Economics – Government and the macroeconomy - Monetary policy | e-Consult

Money Supply: The total amount of money available in an economy at a given time. This can be measured in different ways, with the most common definitions being:

• M0 (Narrow Money): Includes physical currency in circulation and commercial banks' reserves held at the Bank of England.
• M1 (Broad Money): Includes M0 plus demand deposits (checking accounts) and other checkable deposits.
• M2 (Even Broader Money): Includes M1 plus savings deposits, money market funds, and short-term deposits.

Monetary Policy: Actions undertaken by a central bank (like the Bank of England) to manipulate the money supply and credit conditions to stimulate or restrain economic activity. The main aim is to achieve price stability (control inflation) and promote economic growth.

How the Bank of England controls the money supply: The Bank of England can use several tools:

• Open Market Operations (OMO): Buying or selling government securities (like gilts).

  • Buying gilts increases the money supply as the Bank of England pays for them, injecting money into the economy.
  • Selling gilts decreases the money supply as the money flows from the public to the Bank of England.

• Bank Rate (Official Bank Rate): The interest rate at which the Bank of England lends money to commercial banks.

  • Raising the Bank Rate makes borrowing more expensive for commercial banks, leading them to charge higher interest rates to their customers. This reduces borrowing and spending, thus reducing the money supply.
  • Lowering the Bank Rate makes borrowing cheaper, encouraging banks to lend more, increasing the money supply.

• Quantitative Easing (QE): A form of OMO where the Bank of England purchases longer-term government bonds or other assets to lower long-term interest rates and increase the money supply. This is typically used when the Bank Rate is already near zero.