ACCA FM Syllabus B. Financial Management Environment - Monetary Policy - Notes ^{3 / 6}

The volume of money in circulation is called the money supply

The price of money is called interest rates

Discussion:

Monetary policy is one of the ways the government can impact the economy. 

By impacting the effective cost of money, the government can affect the amount of money that is spent by consumers and businesses.

1. Affect on Growth

   When interest rates are high, fewer people and businesses can afford to borrow, so this usually slows the economy down. 

   Also, more people will save (if they can) because they receive more on their savings rate.

   When the central banks set interest rates it is the amount they charge other banks to borrow money. 

   This is a critical interest rate, in that it affects the entire supply of money, and hence the health of the economy.

   High interest rates can cause a recession.

2. Affect on Exchange rates

   High interest rates attracts foreign investment ⇨ increase in exchange rates:

   • exports dearer
   • imports cheaper.

3. Effect on Inflation

   High interest rates should restrict growth and inflation