Example Worksheet Resource

The effectiveness of monetary policy during a credit crunch

. State: One of the main causes of the recent recession was banks lending money to firms and individuals who simply could not afford to pay this money back. As a result, many banks have now lost confidence in the system, and are unwilling to lend out more money for fear of it not being repaid.

. Explain: This has undermined the effectiveness of monetary policy. When the bank lowers interest rates, this should lead to more borrowing and so more consumption and investment. However, in the recession, it is not the cost of credit that has been the issue - it is the availability of it. Even when the interest rate is lowered, banks still are not willing to lend out money due to lack of confidence.

. Conclude: As a result, the focus of monetary policy has had to change. Rather than rely solely on interest rates, the MPC has turned to injecting new money into the economy (known as quantitative easing) through the purchase of bonds and other assets. By doing so, the MPC are effectively lending money directly to the government and firms, bypassing the banks in the process. The government has also turned to fiscal policy as another tool to assist the economy, due to the relative ineffectiveness of monetary policy.