Unit 2 Macro: Monetary Policy and Inflation Glossary

A selection of key terms on monetary policy and inflation


Creeping inflation
Small rises in the general level of prices over a long period of inflation

A persistent fall in the general price level of goods and services

A fall in the rate of inflation. This means a slower increase in prices but not a fall in prices (deflation)

Inflation target
The Bank of England has an inflation target of 2% for the consumer price index

School of economic thought that considers money supply as the main factor influencing the economy, and monetary policy as the key instrument of government decision-making. Controlling money supply should ensure steady economic growth and a healthy price environment. Opposed by the Keynesian school, which considers fiscal policy as the key macroeconomic tool

Money illusion
Money illusion occurs when people confuse nominal and real values when making economic decisions. Money illusion is most likely to occur when inflation is unanticipated, so that people’s expectations of inflation turn out to be some distance from the correct level.

Money supply
The entire quantity of a country’s commercial bills, coins, loans, credit, and other liquid instruments in the economy.

Negative interest rate
An interest rate that is below zero. For real interest rates, this can occur when the inflation rate is higher than nominal interest rates.

Neutral interest rate
A neutral interest rate is a rate of interest that neither deliberately seeks to stimulate aggregate demand and growth, nor deliberately seeks to weaken growth from its current level. In other words, a neutral rate of interest would be that which is set at a level which encourages a rate of growth of demand close to the estimated trend rate of growth of real GDP.

When an economy is growing too fast and aggregate supply cannot keep up with demand, leads to a rise in demand-pull and cost-push inflation

Price stability
A period of low stable inflation of between 1-4% when price rises are modest

Data from Timetric.

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United Kingdom from Timetric

Relative deflation
The term “relative deflation” is generally used to describe an economy with an inflation rate, which has not necessarily descended into negative territory, but is markedly lower than comparable economies

Retail Price Index (RPI)
The RPI is broadly similar to the CPI but includes mortgage repayments and some taxes, and excludes the top 4 per cent of earners. It is used to calculate increases in wages, state benefits and pensions.

A combination of slow economic growth and rising inflation, can lead to stagflation. The most notable recent period of stagflation occurred during the 1970s, when world oil prices rose dramatically, and UK inflation rose at one point to nearly 30 per cent.

Wage price spiral
Workers bid for higher wages because they have seen their real income eroded by rising prices. This can lead to a further burst of cost-push inflation in an economy.

Monetary Policy

When the value of an asset or exchange rate increases in value relative to another

Credit crunch
Situation where banks across the economy reduce lending to each other due to falling confidence that loans will be repaid

A fall in the market value of one exchange rate against another

Euro Zone
17 countries (currently) that share a single currency (the Euro) and a common policy interest rate set by the European Central Bank

Expansionary monetary policy
A policy to expand money supply and boost economic activity, mainly by keeping interest rates low to encourage borrowing by companies, individuals and banks. May also involve quantitative easing (bank purchases of government bonds)

Policy interest rate
The base / policy interest rate set by the Monetary Policy Committee of the Bank of England when operating monetary policy

Data from Timetric.

To view this graph, please install Adobe Flash Player.

United Kingdom from Timetric

Quantitative easing
Attempts by a central bank to increase the base supply of money by buying debt off banks and other financial institutions. Has occurred in the UK since 2009

Real interest rate
Nominal (money) rate of interest adjusted for inflation

Data from Timetric.

To view this graph, please install Adobe Flash Player.

United Kingdom from Timetric

Transmission mechanism
The process by which changes in interest rates and/or the supply of money work to affect demand, output and prices


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