The Bank of Englands Monetary Policy - Assignment Example

?BUSINESS SCHOOL - Undergraduate Assignment Feedback Frontsheet SECTION A: (to be completed by the Please complete Section A in Block Capitals making sure that you include your Student Number, Module Code and Group Number. FAILURE to do so may result in your assignment being delayed. If you are unsure of any of the above please check at the Business School Student Centre Reception. Student Number (s): 0843375 Programme:(e.g. Business Management) Business Economics Module Title: (e.g. Studying for Business) Monetary Economics Seminar Group 1 Module Code: FE3011 Word Count 1,564 I confirm that no part of this assignment. except where clearly quoted and referenced. has been copied from material belonging to any other person e.g. from a book. handout, another student. I am aware that it is a breach of UEL regulations to copy the work of another without clear acknowledgement and that attempting to do so renders me liable to disciplinary proceedings. SECTION B: (to be completed by the tutor marking assignment) Assessment Criteria: Weightings Criteria based Feedback Mark Achieved Logical Sequence and Development 10% Evidence of Background Reading 20% Appropriate Depth of Analysis 30% Critical Evaluation of Issues/Results 25% Referencing Technique 5% Presentation including Language and Grammar 10% TOTAL MARKS 100% Good practice demonstrated: Aspect to consider for improvement: Tutor's Name: Date Received: PROVISIONAL MARK Explain the legal framework for the Bank of England’s Monetary Policy and discuss the effectiveness of central bank independence in times of financial crises. Module Code:FE3011 Module Title: Monetary Economics Student Number:0843375 Table of contents 1. Introduction 3 2. Bank of England – monetary policy 3 2.1 Overview of Bank of England’s monetary policy 3 2.1.1 Monetary policy, elements and effects 3 2.1.2 Monetary policy of Bank of England 4 2.2 Legal framework for the Bank of England’s Monetary Policy 5 2.3 Effectiveness of central bank independence in times of financial crises 7 3. Conclusion 8 References 9 Appendix 10 1. Introduction In most countries, the standardization of the economy is considered as a challenging task, even when the level of national resources, as combined with commercial activities, is characterized as quite satisfactory. The development of an effective monetary policy can help a country to secure its position in the international community; at the same time, a successful monetary policy can help a country to keep the control on its industries and resources, ensuring the availability of capital required for the completion of local government’s plans. This paper focuses on the examination of the legal framework for the Bank of England’s monetary policy; furthermore, the effectiveness of the Bank’s independence in times of financial crises is discussed referring to the literature and the empirical evidence developed in the specific field. It is proved that, in the UK, the monetary policy is influenced by a series of factors; for this reason, the legal framework for the Bank of England’s monetary policy is not standardized. In its current form, the legal framework for the Bank’s monetary policy is quite flexible, incorporating rules for regulating all aspects, as possible, of the national economy. In the future, particular emphasis should be given on the valuable role of Bank of England in securing payments across the country, regulating the monetary policy of the country and controlling the activities of bank institutions (HM Treasury 2008, p.86). 2. Bank of England – monetary policy 2.1 Overview of Bank of England’s monetary policy 2.1.1 Monetary policy, elements and effects In order to understand the characteristics and the effectiveness of Bank of England’s monetary policy, it would be necessary to refer primarily to the elements of monetary policy, as part of a country’s economic life. According to Ruddock (2008), the monetary policy of each country is set and monitored by the country’s central bank (Ruddock 2008, p.122). One of the most important missions of monetary policy, as a key framework of the national economy, is ‘to determine the availability and price of credit in the economy’ (Ruddock 2008, p.122). The term credit in the above case refers to both the public and the private sector. It should be noted that the targets and the elements of monetary policy may be differentiated across countries. More specifically, in certain cases, the monetary policy focuses on specific features of the economy, as for example ‘the external exchange rates’ (Ruddock 2008, p.122). 2.1.2 Monetary policy of Bank of England Generally, in all countries the monetary policy is determined and controlled by the local central bank. Of course, the government has the power to intervene and suggest alterations, especially at the level that the central bank’s monetary policy is opposed with the governmental plans on economy. In certain cases, the development of different views in regard to the monetary policy’s elements and priorities can lead to strong conflicts between the central bank and the government (Enoch & Green 1997). These oppositions are usually caused because of policy failures, but also because of the lack of accurate information (Schaechter, Stone, & Zelmer 2000, p.4). Within the UK no such problem seems to exist; in fact, in the above country the laws governing the relationship between the Bank of England and Treasure are characterized by flexibility (Enoch & Green 1997, p.407); it is implied that the country’s monetary policy is determined by the Bank of England in cooperation, even partially, with the British government. UK is a key member of the European Union. Even if the country has not joined the euro zone, still its monetary policy is necessarily influenced by the turbulences and the downturns of the European market (Abrams et al 1998). For controlling the effects of these turbulences on British economy, the Bank of England has incorporated flexible monetary policies which can be aligned with the European Union’s monetary policy, in case that there is need for such support. The monetary policy of Bank of England has been periodically alternated following the changes in the status of British economy. These alterations have caused delays in the achievement of the monetary policy’s objectives. The above phenomenon has been analysed in a ‘Report prepared for the 1999 Central Bank Governors’ Symposium’ (Mahadeva & Sterne 2000, p.10). The Bank’s monetary policy is based on the following rule: ‘a high share of gilts are hold within the Bank’s portfolio’ (Reinhart 2012). In this way, the bank controls liquidity risks as related to unexpected market turbulences. A few days ago, the Bank of England decided to avoid changes on its monetary policy; ‘the 50 billion pounds of quantitative easing’ (Milliken 2012) which were used for supporting the markets needs during the crisis, were considered as adequate; an increase of the above amount would be risky, since the rate of recovery of the UK economy was estimated to be lower than expected (Milliken 2012). 2.2 Legal framework for the Bank of England’s Monetary Policy The Bank of England was established through the Bank of England Act 1694 (Bank of England, Legislation 2012). Since then, a series of legislative texts have been developed for securing the Bank’s status, as a key body in the country’s economic framework; reference can be made, for example to the Bank Charter Act 1844, the Bank of England Act 1946 and the Banking Act 2009 (Bank of England, Legislation 2012). The key parts of Bank of England’s operations are governed by the Bank of England Act 1998, which set the terms for the Bank’s ‘governance and accountability’ (HM Treasury 2008, p.86). In the context of this Act, Financial Services Authority was given the power to supervise the activities of banking institutions; in the past such only the Bank of England could proceed to such activity (Mwenda 2006, p.82). Another characteristic of the 1998 Act is the following one: the Act increases the power of the Bank of to define the terms of the country’s monetary policy. Through the section 10 of the above Act the Bank can act independently from the Treasury in regard to the monetary policy, meaning that Treasury has, no more, the power to give directions to the Bank of England in regard to the country’s monetary policy (Mwenda 2006, p.82). Of particular importance is also the section 12 of the 1998 Act; in the specific section emphasis is given on the power of the Bank of England to set the elements of price stability and implement the government’s economic policy, as related to price stability (Mwenda 2006, p.82). In any case, the 1998 Act gave to the Bank of England the right to decide on the interest rates, a fact that highly enhanced the Bank’s independence (Bank of England, monetary policy framework 2012). The Monetary Policy Committee defines the interest rates after taking into consideration the inflation targets, as announced by the Chancellor of Exchequer (Bank of England, monetary policy framework 2012). 2.3 Effectiveness of central bank independence in times of financial crises In most countries, the independence of the central bank is regarded as a tool for hiding from the public, critical information in regard to the actual status of the banking sector (Krehm 2008, p.223). In other cases, such independence is promoted so that inflation is kept at low levels, a fact that benefits people of low social classes (Krehm 2008, p.223). The independence of the Bank of England was first established, in practice, in 1997 (Santomero, Viotti & Vredin 2001, p.178). In fact, the independence of Bank of England has been related to the Bank’s daily operations and not so much on its ability to take initiatives without the control of the state. Indeed, ‘the UK Chancellor of the Exchequer has retained his power to set the numerical inflation target for the Bank of England’ (Santomero, Viotti & Vredin 2001, p.177). Santomero, Viotti & Vredin (2001) note there are no limitations in regard to the times that the UK Chancellor can change his view on the inflation target, meaning that the power of the Bank of England to act independently can be easily vanished (Santomero, Viotti & Vredin 2001, p.177). As a factor promoting initiatives for increasing its capital, the independence of the Bank of England can be highly valued. In the context of current financial crisis, the above characteristic can negatively affect the stability of the economy, at the following point: the capital of the Bank is effectively protected through high collaterals (Kunt, Evanoff & Kaufman 2011, p.298). Still, there are certain parts of the Bank’s funds, such as the last – resort loans that are covered by the state (Kunt, Evanoff & Kaufman 2011, p.298). This means that in case of a financial crisis, the taxpayers would have to cover the losses caused by these loans (Kunt, Evanoff & Kaufman 2011, p. 298). Moreover, the Bank of England is not involved in the activities transferred to FSA; in this way the quality and the accuracy of information exchanged between the two bodies has been worsened, a problem that led to the Northern Rock case, through which the country’s economy has been severely affected (House of Commons 2008, p.33). Protecting its independence the Bank of England has avoided the exchange of critical information in regard to the above case with the Financial Services Authority. As a result, the case of Northern Rock highly surprised regulators and the British government. During periods of financial crises central banks secure liquidity in the market; keeping its independence can help a central bank to respond more effectively to the above role, ensuring that its capital will not set in risk (Sandararajan 1991, p.35). A similar approach can be used to explain the role of Bank of England’s independence during periods of financial crises. 3. Conclusion The development of effective monetary policies is depended on a series of factors. In highly developed countries, such as Britain, the role of the central bank in the success of monetary policy can be critical. In the particular country, the independence of the Bank of England within the local economic system has been considered as enhancing the Bank’s potentials to support the economy. In practice, these potentials can be reduced, especially when cooperation with other bodies, also participating in the development of the monetary policy, is poor. The legal framework of the Bank has secured its potentials to support the local economy during periods of crises, as proved in the last financial crisis, of 2008. Of course, failures are unavoidable but the development of effective communication with other bodies and the government, as explained above, has helped the monetary policy of the Bank to remain effective during periods of financial crises. 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