ā Strengths of Monetary Policy
- Speed of implementation ā the central bank can change rates quickly (monthly meetings), unlike fiscal policy which requires parliamentary approval.
- Independence ā free from political pressure ā more credible and consistent.
- Flexibility ā rates can be adjusted in small increments (0.25% steps).
- Proven track record ā most developed economies successfully controlled inflation from the 1990sā2010s using inflation targeting.
- Low direct cost ā doesn't require government spending or increase the fiscal deficit.
ā Limitations of Monetary Policy
- Time lags ā it takes 12ā24 months for rate changes to fully affect the economy. The central bank must act on forecasts, which may be wrong.
- Liquidity trap.
- Zero lower bound ā interest rates can't go (much) below 0%, limiting the central bank's ability to stimulate further.
- Ineffective against cost-push inflation ā raising rates reduces demand but doesn't fix the supply problem (e.g. oil shock). Can worsen unemployment.
- Blunt instrument ā affects the whole economy equally. Can't target specific regions or sectors.
- Depends on confidence ā if businesses and consumers are pessimistic, they won't borrow even at low rates ('pushing on a string').
Real-world example: After 2008, the US Federal Reserve cut rates to near zero and launched massive QE programmes ā but the recovery was slow because banks were reluctant to lend and consumers were focused on paying down debt (liquidity trap conditions).
See how examiners mark answers
Access past paper questions with model answers. Learn exactly what earns marks and what doesn't.
Try Exam Vault Free7-day free trial ā¢ No card required
šµ Quantitative Easing (QE)
Quantitative easing (QE).
When is QE used?
When conventional interest rate cuts have reached the zero lower bound and the economy still needs stimulus. QE was used extensively after the 2008 crisis and during COVID-19.
Evaluation
- ā Provides stimulus when conventional tools are exhausted.
- ā Lowers long-term borrowing costs for firms and households.
- ā May inflate asset prices (housing, stocks) ā worsens wealth inequality.
- ā Risk of inflation if too much money is injected.
- ā Difficult to reverse ('unwinding QE' can destabilise markets).