Expansionary Monetary Policy

Key Term: Monetary Policy is a process of changing interest rates or manipulating the money supply by the authorities to try and control the rate of inflation, maintain sustainable economic growth and influence the exchange rate.

A committee of 9 members on the Monetary Policy Committee (MPC) meet monthly and vote to decide future interest rates. If they feel the inflation rate is likely to go above the target due to economics growth then they will increase interest rates to moderate demand and keep inflation low. 


Expansionary Monetary Policy or reducing the base lending rate will increase aggregate demand (AD=C+I+G+(X-M)) as:

• ·      It will make borrowing cheaper, therefore consumers will spend more on credit, which overall will increase spending, Equally firms will be more willing to invest money and borrow more.
• ·      Costs of borrowing such as mortgages become cheaper therefore people have more disposable income, causing an increase in consumption, therefore AD increases.
• ·      It makes saving money less appealing as people can gat a higher return in investment by spending and money in the bank is not increasing at the same rate as prices therefore consumers spend early to avoid additional expense.
• ·      Exchange rates will decrease as it becomes less attractive to save in UK banks. Therefore this decrease demand for the Pound Sterling and decreases the exchange rate.  This will also increase demand for net exports (X-M) as because exports appear cheaper and imports more expensive.