Monetary policy Cambridge IGCSE Economics revision
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In plain words
The interest rate is the price of borrowed money, and the reward for saving. Nudge it up, and people borrow less and spend less. Nudge it down, and spending picks up. That makes it a powerful lever on the whole economy.
Controlling interest rates and the amount of money is monetary policy, and it is usually the job of the central bank.
5 things to know
- Monetary policy is the use of interest rates and the money supply to influence total demand. The money supply is the total amount of money in the economy.
- A rise in the interest rate makes borrowing dearer and saving more rewarding. Households spend less and firms invest less, so total demand falls and inflation falls. The risks are slower growth and higher unemployment.
- A cut in the interest rate does the opposite: more borrowing, more spending and investment, more output and jobs, and a risk of higher inflation.
- A higher interest rate also attracts savings from abroad, which raises the value of the currency.
- A central bank can increase the money supply by buying assets from banks, which gives them more money to lend.
Tips and tricks
- Explain the mechanism in steps, never in one jump: interest rate up, so loans cost more, so less borrowing, so less spending, so lower demand, so lower inflation.
- People with a home loan are hit directly: their repayments rise with the interest rate, leaving them less to spend on everything else.
It lands in your notebook with its questions as flashcards.
Monetary policy: 5 questions and answers
These are the quiz’s questions. Do the quiz first, then come back here for the ones that got you.
Which is a monetary policy measure?
Monetary policy works through interest rates and the money supply.
Who usually sets the main interest rate in an economy?
It is the central bank's main tool.
Interest rates rise. What are households most likely to do?
Loans cost more and savings earn more.
A central bank wants to reduce inflation. It is most likely to
Dearer borrowing reduces spending and total demand.
What is a risk of raising interest rates?
Lower spending means firms sell less and may need fewer workers.
Quiz
5 questions
Tap an answer and you’ll see straight away whether it’s right, and why.
Worksheet
3 questions, 8 marks. Write your answers on paper, then check them.
Monetary policy
Cambridge IGCSE Economics 0455 · 8 marks · papermunch.org
Name ______________________________ Date ______________
Define monetary policy.[2]
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The use of interest rates and the money supply, usually by the central bank, to influence total demand in the economy.
Explain how a rise in interest rates can reduce inflation.[3]
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Borrowing becomes more expensive and saving more attractive, so households spend less and firms invest less. Total demand falls, which reduces the upward pressure on prices.
Explain how a cut in interest rates might increase economic growth.[3]
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Loans are cheaper, so consumers borrow and spend more and firms borrow to invest in new equipment. Total demand rises and firms increase their output.
Answers: Monetary policy
- 1. The use of interest rates and the money supply, usually by the central bank, to influence total demand in the economy.
- 2. Borrowing becomes more expensive and saving more attractive, so households spend less and firms invest less. Total demand falls, which reduces the upward pressure on prices.
- 3. Loans are cheaper, so consumers borrow and spend more and firms borrow to invest in new equipment. Total demand rises and firms increase their output.