Discuss the extent to which recent changes in monetary policy have impacted upon the UK economy

The recent changes in monetary policy, which is the manipulation of monetary variables such as the Bank of England base rate and the amount of liquidity in commercial and retail banks to influence the level of aggregate demand and long-run aggregate supply in the economy, have included a reduction in the Base Rate from 5.5% to a historic low of 0.25% and a new Quantitative Easing round which has resulted in a total of £435 billion of Quantitative Easing, alongside a new Term Funding Scheme which penalises commercial banks if they do not lend to individuals and businesses at the Base Rate.

One impact of the large reduction in the Bank of England base rate has been that consumption and in the UK economy have increased leading to an increase in output, or real GDP. This has been illustrated through the fact that the low base rate has increased asset prices in the UK because houses now offer a relatively higher rate of return compared to saving, which in turn has led to a positive wealth effect on many households in the UK because 64% of households in the UK own their homes, thus increasing consumption as households draw upon their positive equity, shifting AD from AD1 to AD2 and increasing the output level from GDP1 to GDP2. This has been coupled with a positive income multiplier, which is when the final change in GDP is greater than the initial injection (consumption) that caused it, illustrated by the fact that growth was forecast to be 2.1% in 2017.

However, there has been evidence of a liquidity trap that has prevented the low Base Rate from lowering the commercial bank interest rate. This is because the profitability of banks decreased sufficiently in the Financial Crisis of 2008 that banks have absorbed the additional liquidity to make up for the loss of liquidity experienced during the Credit Crunch, leading to a negligible change in real interest rates given that inflation was at a low of 0% before the EU Referendum vote, and leading to no tangible increase in lending and consumer spending on durables which composes 60% of AD, thus leading to a lower outwards shift in GDP than might have been expected and a lower increase in GDP.