Explain How Monetary Policy Can Raise the Level of Aggregate Demand in the Short Run. Discuss the Relevance of Your Answer for the Uk Since 2009.

Topics: Monetary policy, Central bank, Inflation Pages: 4 (1035 words) Published: January 26, 2013
Government can influence economic activity in two ways: monetary policy and fiscal policy. Fiscal policy affects the economy by changing the volume of government spending or taxes. Monetary policy is the regulation of the money supply, weight of gross of aggregate demand, which in turn influences the interest rate. There are two types of monetary policy: monetary expansion and monetary contraction. In the first case, the money supply is increased, in the second case on the contrary decreased. This essay reflects the ways the monetary expansion increases the money supply and it can also be seen how the rise in money supply affects the output. The present essay shows how Bank of England raises demand by such policy. The first part of essay shows the conventional ways of monetary policy and the second part reflects unconventional ways of influencing money supply. The significance of such policy will be proved by illustration of the monetary policy of Bank of England since 2009.

The first conventional method of monetary policy is open market operations. This means that Central Bank can affect the money supply by purchasing and selling bonds. When the Central Bank buys bonds, it puts money to the circulation. On the contrary when the Central Bank sells bonds, it takes money away. If the money supply becomes more this means that in equilibrium the LM curve will shift to the right which leads to a lower interest rate. If the interest rate is lower, then people are more willing to spend than to save, which in terms increase consumption, hence output will increase.

The other conventional monetary policy is reserve requirements. When the Central Bank increases bank reserve ratio, the banking sector's excess reserves are decreased. This brings to a decrease to the supply of money. Consistently, a reduction in reserve requirements stimulates a rise in the supply of money. The more money in use, the higher is the production. It prevents banks from lending as much money...
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