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Demand Management (Demand-side Policies) — Monetary Policy · Paper 1 — Free Economics SL Practice Questions

1FoundationSAQ-SEffects of monetary policy on the economy4 marksPaper 1~6 min
The central bank of Econland has lowered its policy interest rate from 6%6\% to 4%4\%.
(a)
Define the term "expansionary monetary policy". [2 marks]
(b)
Explain how the reduction in the policy interest rate is intended to affect aggregate demand in Econland. [2 marks]
diagram

Solutions

2MasterySAQ-STools of monetary policy (interest rates, reserve requirements)6 marksPaper 1~9 min

Data

Assume short-run aggregate supply (SRAS) is upward sloping and AD slopes downward.
The central bank of a small open economy is concerned about rising inflation, currently at 7%7\% per year, well above its target of 2%2\%. The central bank decides to increase the policy interest rate from 3%3\% to 5%5\%.
(a)
Explain two transmission mechanisms through which this increase in the policy interest rate causes aggregate demand (AD) to fall. [2 marks]
(b)
Using a fully labelled AD/AS , analyse the intended effect of this monetary policy action the economy's price level and real output, and evaluate one potential conflict this policy may create with another macroeconomic objective. [4 marks]
diagram

Solutions

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