The Official Bank Rate and Macroeconomic and Financial Circumstances - Coursework Example

FINANCIAL MARKETS AND MONETARY POLICY The Official Bank Rate and Macroeconomic and Financial Circumstances The official bank rate is also referred to as Bank of England base rate which is the rate of interest that the Bank of England levies Banks for collateralized overnight loans. The British government uses this as the main monetary policy implementation. It is more comparable to the United States’ discount rate compared to the Federal funds rate. The safety for giving loans can be among the list of the authentic collaterals which are transacted as overnight Repos that might be very expensive to banks at times (Capie, 2010, p. 510). The official bank rate has been in existence in a variety of forms ever since 1694 and has been within a range of 0.5% and 17%. Since then it has been varying over the years where the present name ‘official bank rate’ was initiated in 2006 replacing the former ‘Repo Rate’ that existed till 1997. The rate of interest is levied by the nation’s central bank or the Federal bank on lending or advances to regulate the supply of money in the banking sector and overall economy. This is essentially conducted on a quarterly term to regulate the inflation rate and strengthen the nation’s rates of exchange. Any deviation in the bank rates stimulates a ripple-impact as it affects every sector of the economy. For example, the stock prices in the exchange market seem to respond to the changes in the interest rates. A variation in the bank rates has an impact on the customers as it affects the prime rates of interests for individual loans. The Bank rate is the rate at which the Bank of England gives to the commercial bank for the extra reserves being kept in safe custody of the Central Bank (Ciro, 2012, p. 122). Conventionally, the treasury determines the rates of interests. But upon the reforms that occurred in 1992, the policy makers organized several meetings and minutes were published, yet they were not autonomous of the state which resulted into a perception that political forces were overshadowing what was stipulated to be fiscal decisions on the monetary policy. In 1997 there was operational accountability to determine the interest rates which was granted to the autonomous Bank of England by Gordon Brown-the Chancellor of Exchequer. Several principles were set for the establishment of the Monetary Policy Committee (MPC) that was enacted in the Bank of England Act 1998 (OECD, 2009, p. 31). The Act also spelled out the accountability of the MPC: this include; meeting on monthly basis, the membership consists of the governor, two deputy governors, two executive directors of the bank and four members selected by the Chancellor. All minutes for the meetings must be published within a period of six weeks (Great Britain, 2011: 105). The Act granted the state the accountability for determining the targets for the price stability, growth and employment goals in a period of one year. The state also relicensed the prerogative to give directives to the Bank on the rates to be set in moments of emergency. In the initial decade, the MPC maintained interest rates comparatively strong amidst 3.5% and 7.5%. Later on amid 2008 October and March 2009 the base rate was split six times to a low of 0.5% with aim of preventing spur growth and deflation. Later on in March 2009, a program known as Quantitative easing (QE) was launched by the MPC which earlier on injected £ 75 billion into the economy. By March 2010 MPC took a vote to maintain the rates at 0.5% and increased a sum of money reserved for QE to about £ 200 billion an amount that was again raised by £ 75 billion in the last quarter of 2011. The MPC declared another £ 50 billion of QE in 2012 February which brought the amount to a total of £ 325 billion while correspondingly maintaining the base rate at 0.5% (Muraleedharan, 2009, p. 87). There were various circumstances that led to this act by the MPC in increasing the QE to a total of £ 325 billion. The economic concerns such as high unemployment and low inflation were on the rise which necessitated the move. Thus reducing the rates of interests would indeed affect adversely the economy in case the citizens who relied on the income from interests would spend less in reaction to their diminished income. Universally, the Bank of England assumes that the merit of the low interests outdoes this impact even though they regularly accept that the superiors may be affected as damage to their collateral. In the European Union, the financial economists for the World Pensions Council also contend that the QE-stimulated essentially low rates of interests might have a negative effect on the below the average funding status of the pension funds (Barry, 2009: 38). The Asset Purchase Programme and the Effects Does It Have On Macroeconomic Performance in the UK Quantitative easing might result into a higher inflation than expected in case the amount of easing needed is excessively estimated and excess money is established by the acquisition of liquid assets. On top of that it can turn out a disaster if the banks hold to loan money to small households and business with an aim of spurring demand. QE can also efficiently reduce the procedures of deleveraging because it reduces the output. It must be noted that securities that backed by mortgages in such a manner that they are acquired as part of the QE program are not found on liquid assets (Boyes and Melvin, 2009, p. 314). Moreover, their acquisition does not involve risks of inflation. In case the easing led into a diversification of supply of money, it would be anticipated that to result into an effect of inflation as shown by the annual inflation rate. This is because, there exists a time lag amid growth of money and inflation and the pressure of inflation which is related the growth of money from QE. This might be created prior to the action of the central bank in counteracting them. Risks of inflation are reduced in case the economy in the system out powers the speed of the rise in the supply of money from the process of easing (Siklos, Bohl and Wohar, 2010, p. 39). In case an economy’s production rises due to increased money supply, the unit currency value might also go up, though there excess currency accessible. For instance, in case a country’s economy was to impel a considerable rise in output at a pace in any case as high as the quantity of monetized debt, the pressures from inflation would be counteracted. This is possible only where member bank indeed loan out extra money as opposed to hoarding excess money. At this time high output in the economy, the central bank often has the choice of reinstating the reserves back to higher phase via increasing the rates of interest or other ways which effectively reverses the steps of easing taken (Withers, 1947, p. 223). Raising the supply of money has a tendency to depreciate the exchange rate of a country against other currencies. This characteristic of QE benefits directly those who export and are staying in the country to perform the QE and debtors who have debts denominated in the country’s currency given that as the currency devalues the debt also devalues. Nevertheless, it has a direct damage to the creditors and those who hold currencies as the actual value of their possessions go down. Currency devaluation on the other hand affects negatively the importers given the cost of goods imported in always inflated by the currency devaluation (IMF, 2008, p. 1203). Through the process of pushing high an assortment of asset prices, asset purchases have enhanced the value of financial wealth by households which is held exterior to the pension funds, though holdings are strongly skewed with the household’s top 5% and assets’ 40% (Baumol & Blinder, 2011: 123). The income from pension of the households in receipt of a pension prior to the beginning of the asset purchase has not been affected by QE. During the valuation of the effect of the QE on the worth of the defined pension funds, it is vital to recall that purchasing of asset raises the value of assets of the pension fund on top of its liabilities. For a classic totally funded scheme of pension, asset purchases are potentially to have had a wide effect on the resultant value of the pension scheme (Barrell, 2000, p. 57). The asset purchase program has also an impact on the savers. The savers can be described in various ways and the effect of QE will divergent relying on the group that is taken into consideration. One of the descriptions might be households with higher worth of the financial assets compared to financial liabilities such as debts. A different definition of saver could be households with gross savings even though their debts might be bigger than their assets. That is to say they have negative net financial assets. Households might have a perception of themselves as savers in case they often save cash out of their usual earnings, even though their net financial assets are negative (Koch and Macdonald, 2010, p. 37). For example, in a situation where QE is not present, savers might have been more probable to lose their employment opportunities or experienced their firms they possessed go out of operation. Furthermore, they do not take into consideration of the effect of the QE on the rate of inflation and thus the method these flows of finances translate into actual spending on the products and services. Other aspects being constant, high inflation rates due to QE lowered the volume of products and services that could be purchased by the households with a particular quantity of spending. There are probably to be repercussions of distribution due to increased inflation (Sarno and Taylor, 2005, p. 11). The MPC determines the monetary policy for the country at large to meet the inflation objective of the state. Variations in the rates of interests and asset purchases funded by remitting reserves through QE, unmistakably has implication of distribution. In case the Bank does not make asset purchase, most individuals in the UK would have been in a worst situation. Growth of economy would have been at a lower level. The unemployment rate would have been at its highest level and majority of the firms would have been put out of business. This would eventually lead to a considerable damaging impact on the pensioners, savers and house markets. All evaluations of the impact of asset purchases must be perceived in this dimension. The asset purchase by the Bank have been nearly wholly of gilts, which results into prices of gilts to go high and output to go down. Ultimately this in turn has resulted to a rise in demand for other different assets inclusive of corporate bonds and equities. Consequently, the asset purchases by the Bank have also raised the value of a broad assortment of assets apart from gilts (Wang, 2009, p. 97). Bibliography Barry, J 2009, Advances in Ecopolitics. Vol. 3. Bingley, U.K., Emerald. 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