What is the monetary policy transmission mechanism?

It describes how changes in bank rate affect the real economy and inflation through various channels.

In the interest rate channel, what happens first when the bank rate changes?

Commercial bank lending and saving rates adjust in response.

How does a change in bank rate affect the cost of borrowing for households and firms?

A higher bank rate increases borrowing costs; a lower bank rate reduces them.

How does a change in bank rate affect the return on saving?

A higher bank rate increases returns on savings; a lower bank rate reduces them.

What is the ultimate effect of the interest rate channel on the economy?

Consumption and investment decisions are affected, influencing aggregate demand.

In the exchange rate channel, what happens when UK interest rates rise?

Hot money inflows increase as foreign investors seek higher returns.

AQA A-Level Economics 7136

Economic Methodology and the Economic Problem

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Financial Markets and Monetary Policy

The monetary policy transmission mechanism

4 things to know
Papers 2 and 3

Overview

The interest rate, exchange rate, asset price and expectations channels.

What you need to know

Answer each one before you reveal it.

Your recallNot started

Evaluation

How does a change in bank rate work through the cost of borrowing and the return on saving?

Numbers

What happens to the exchange rate when demand for sterling increases due to higher interest rates?

Process

How do rising asset prices affect household wealth?

Key term

What is the effect on consumption when household wealth increases due to rising asset prices?

Questions from this subtopic

Each one with the model answer underneath.

1
What is the monetary policy transmission mechanism?
Model answer
It describes how changes in bank rate affect the real economy and inflation through various channels.
2
In the interest rate channel, what happens first when the bank rate changes?
Model answer
Commercial bank lending and saving rates adjust in response.
3
How does a change in bank rate affect the cost of borrowing for households and firms?
Model answer
A higher bank rate increases borrowing costs; a lower bank rate reduces them.
4
How does a change in bank rate affect the return on saving?
Model answer
A higher bank rate increases returns on savings; a lower bank rate reduces them.
5
What is the ultimate effect of the interest rate channel on the economy?
Model answer
Consumption and investment decisions are affected, influencing aggregate demand.
6
In the exchange rate channel, what happens when UK interest rates rise?
Model answer
Hot money inflows increase as foreign investors seek higher returns.

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Economic Methodology and the Economic Problem

Individual Economic Decision Making

Price Determination in a Competitive Market

Production, Costs and Revenue

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AA higher bank rate increases borrowing costs.

BA higher bank rate increases returns on savings.

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Monopsony means a market dominated by one buyer.

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