Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Part IV


Examining Macroeconomic Policy


© John Wiley & Sons


The Bank of England holds billions of pounds in bonds purchased by the UK government. The free article at


www.dummies.com/extras/macroeconomicsuk explains why the Bank doesn’t

just cancel the payback of these bonds.

In this part …


Take a look at how monetary policy determines the amount of money in circulation and what effect this has on the economy and inflation.


See how policy makers influence the economy through the government’s fiscal policies of expenditures and taxation.


Examine the Phillips curve to understand how unemployment and inflation are related in the short run and the long run.

Jump into the debate about whether policy makers should follow policy rules or use their discretion to control the economy.

Chapter 10


Using Monetary Policy to


Influence the Economy


In This Chapter


Understanding how monetary policy works


Targeting the level of inflation


Stimulating the economy with quantitative easing


Discussing what monetary policy does (and doesn’t) influence
Imagine a world in which you can print your own money. If you’re a little short of cash one day, you simply fire up the printing press and, voilà, problem solved! That house you always wanted but could never afford? No problem, just run the printing press for an hour or so and you’re fine. In fact, in an age of electronic money you needn’t even do that – with the touch of a button you’d just create the money!

Staying in your dream world for a minute, think about this question: if you print, say, £1 million and buy the house of your dreams (or in London the small flat of your dreams), who’s actually paying for the house? Certainly not you: you just conjured up the money from thin air and so acquired the house ‘for free’. Equally, the seller doesn’t care that you printed the money – so long as it’s genuine and has the Queen’s head printed on it, he’s happy. So who’s paying for your luxury pad, if not you or the seller?

The answer is everyone who holds cash (in this case, pound sterling), and that’s pretty much everyone (in the UK). By printing extra money, you effectively devalued all the existing money out there. This devaluation is reflected in now slightly higher prices for goods and services – in other words, inflation. (Check out Chapter 5 to discover exactly how printing money leads to inflation.)

What you discover from this slightly far-fetched scenario is that whoever has the ability to create money is effectively able to tax all the existing holders of

cash. Whoever has the right to create money is awesomely powerful and needs to be trusted to exercise that power carefully. In most countries, the central bank has a monopoly over the creation of money. In this chapter you discover how the central bank increases (or decreases) the amount of money in circulation (called monetary policy) and what effect this behaviour has on the economy and inflation.