Analysis of the Bank of Englands Monetary Policy Committee Decisions - Research Paper Example

Analysis of the Bank of England’s Monetary Policy Committee Decisions Introduction: UK economy is in the hands of recession with a fall in the GDP. It is seen that Bank of England has a major role in stabilizing the financial and economic situation in the country by proposing an accurate bank rate with respect to the inflation rate prevailing in the economy. We can see a sharp cut in the interest rate of bank over the past two year and the bank expects a further cut in the interest rate in the coming years as the inflation rate is expected to reach at 1% by 2010. Quantitative easing policy of the bank can be regarded as an appreciative tool for the recovery of the economy not only now but also in the future prospect. Bank of England – An overview: From the year 1694 onwards, Bank of England plays different roles as Governments banker and debt manager in the UK financial system. It is also known as the Old Lady of Threadneedle Street. In addition to providing service to its customers, the bank also regulates the UK’s foreign exchange and gold reserves. Monetary stability and financial stability – the two core purposes of the bank has helped a lot in shaping the UK economy. Also the bank maintains a Community Involvement Policy to keep a close relation with voluntary sector, organisations and education business. One of the distinctive features is its cartel in issuing the banknotes. Monetary Policy Framework and Monetary Policy Committee: “The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment. Price stability is defined by the Governments inflation target of 2%.” (Monetary policy framework n.d.). Price stability has an important role in the economic stability of the country and the inflation target is announced by the Chancellor of the Exchequer. After the enactment of Bank of England Act in 1998, the interest rate was set by the bank alone except in extreme conditions. In adverse situations, Government gives instructions regarding the interest rate which is restricted for a limited period. The Bank always has to meet the inflation target which is based on Consumer Price Index (CPI). In cases if the annual rate of CPI inflation fluctuates over or below 2%, the Bank submits a report regarding the reasons of inflation fluctuations and the proposed solution to the Chancellor of Exchequer. The Monetary Policy Committee, which is a special committee consisting of nine members out of which 5 is form the Bank and 4 from outside take the decision regarding the interest rate. The member should be aware about the economic condition of the country. Two day monthly meeting is held to take decisions regarding the interest rate which are based on the vote of the committee members. Also based on the economic condition analysis, the bank publishes an Inflation report specifying the forthcoming inflation rate in the UK economy. Decisions taken by the Monetary Policy Committee over the past 24 months: During the last two years, the Committees key issues were dealing the impact of financial market turbulence and energy and food crisis issues. The committee study the financial market developments, changes in the international market, currency fluctuations etc before taking the decision. “the Bank aims to maintain overnight market interest rates in line with Bank Rate so that there is a flat money market yield curve and very little volatility in market interest rates out to the next MPC decision date.” (Review of 2008/09 n.d., p.2). Starting from 2009 June onwards, the decision of the Monetary Policy Committee over the past 24 months is as follows: Review of Monetary Policy Committee Decisions during 2009: We can see a reduction of 0.5% in the bank rate in every month of 2009. The Bank adopted a cut of 50 basis points in the bank rate with an expectation of improvement in the monetary and fiscal condition in the year thus leading to a significant outcome on the income of many businesses and households. During January 2009, the bank was 1.5% and at present the bank rate is 0.5%. During March, the bank took decisions like purchasing of private sector assets under the Asset Purchase Facility using central bank reserves and to buy gilts for fulfilling the overall quantity of purchases if the purchases fell a short of £75 billion target to improve the UK economy. This continued in the month of April also. In May, the US and euro market faced the narrowing of LIBOR spread. 13% rise has shown by the UK equity market and sterling exchange rate showed a slight increase. Maintaining the bank rate at 0.5% and “finance a further £50 billion of asset purchases by the creation of central bank reserves, implying a total quantity of £125 billion of such asset purchases.” (Minutes of the monetary policy committee meeting 6 and 7 May 2009 2009, p.11). are the decisions taken by the committee in the month. In June 2009, we can see a fall of 20 base points in the spread between three month Libor rate and risk-free rate, increase in Euro by 20-50 points and appreciation of Sterling by 4%, depreciation of dollar ERI by 5.5%. In the June meeting, no new initiative decisions has been taken. Maintenance of bank rate at 0.5% and continuation of the asset purchasing program of May amounting £125 billion are the decisions taken in the meeting. We can see that, from March onwards, the monetary policy decisions have changed from interest rate to asset purchasing program. The economic downturn shows a recovery and stabilization of the housing market will make the economy strong in the coming years. Review of the decisions taken by the Monetary Policy Committee during 2008: By analysing 2008 from January to December, we can a tremendous change in the bank rate from 5.5% to 2%. In the first half of 2008, we can see a sharp increase of CPI inflation resulting to be at 5.2%. In September, an expectation of downturn in the economy due to increase in the prices of energy, food etc, has made the bank to reduce the bank rate. Even though there was a reduction in energy prices and VAT, the CPI inflation was still in its position. So during November the bank decided an immediate reduction of 1.5% in the bank rate to meet the inflation target. During the year 2008, to stabilize the market interest rates in line with Bank Rate, the Bank implemented the following decisions: “Held a number of fine-tuning repo operations to inject extra reserves into the banking system; Expanded the range within which reserves were remunerated in order to accommodate the extra reserves supplied; Held fine-tuning and scheduled operations to drain extra reserves injected through long-term repo operations, using Bank of England bills for the first time for such operations; Introduced Operational Standing Facilities to absorb frictions in the overnight money markets.” (Review of 2008/09 n.d., p.2). Review of Monetary Policy Committee decisions during the second half of 2007: In the last quarter of 2007, the Bank of England had cut the interest rate for casting aside inflation concerns and to overcome the deterioration in the financial market. The bank rate was stable during July to November. We can see that the bank rate 5. 5% during June was increased to 5.75% during July 2007. This movement was made based on the estimation that, the CPI inflation rate will fall below the target in the June, which was specified in the May inflation report. (Swint & Ryan 2009). Reasons behind the decision: Presiding inflation rate and deepening recession in the country may be regarded as the main grounds behind every decision of the MPC over the past 24 months. Recession has caused a large decline in the value of Sterling. So one of the main decisions – Quantitative easing has been proposed by the bank for pumping extra cash into the economy. This may increases the consumer spending. (Bank of England holds interest rate again 2009) Paradigm shifts from bank rate strategy to injecting fresh doses of money supply into British economy: The reasons behind the decision could be gleaned from the fact that the main factor behind the current monetary policy is the stability in the currency and the fact that at the moment, the monetary accent has to be more on the quantitative aspect rather than bank rate. Now that the UK bank rate has dropped a new depth of 0.5%, it may not be able to go any deeper, nor could it become negative. Thus, it is now necessary to affect paradigm shifts towards directly pumping funds electronically into the economy in terms of electronic injections of money supply, which could counter the inflationary trends in the economy. However, the monetary policy needs to keep in mind the fact that inflation rate of 2% on CPI measure of consumer prices needs to be kept consistent, while addressing aspects of money supply. (Quantitative easing explained n.d.). What seems important at this stage is a two pronged strategy, on the one hand, the low bank rate needs to stimulate investments, productivity and FDI inflows, while, pumping in large funds would negate inflationary trends and counter balance the ill effects of negative consumer spending. Clearly the idea of the monetary experts are to reach the same goals and objectives but using a different vehicle- seeking stability, strength and substance for the economy. This is also known by another term called Quantitive Easing. Aspects arising out of Quantitive Easing: This is not really printing more currency notes and arranging for its circulation. It is more in terms of the UK government purchasing gilt edged securities and assets and using current internet technology for servicing these assets. Thus, while no actual movements of notes take place, quantitative easing “supports more spending in the economy to bring future inflation back to the target.” (Quantitative easing explained n.d.). While the first method of seeking to inject activity and liquidity into the economy through quantitative easing, the second method is through purchasing of assets. The Committee of MPC would seek consensus in determining the quantum of assets to be purchased to meet inflation targets. This would continue to debate and vote on appropriate levels of bank rate. Asset Purchases: It is seen that Asset purchasing enhances the circulation of money directly into a wider economy and boosts spending. On the one hand, the sellers gain funds which could be used for spending, investing or for being put to used to buy assets, and, in the other, the buyers could put the purchases assets to good use, or even lease or rent to other parties. “More generally, the Bank of England’s purchases of both government and corporate bonds also increase the total demand for those types of assets, pushing up their prices. This is another way in which the Bank’s actions will make it cheaper for companies to raise finance.” (Quantitative easing explained 1996, p.6). Whichever way one looks at it, purchase of assets does help in boosting local revenues and contributing to local economy in various ways. For one thing, more economic activities could propel a bearish economy upwards and also provide job opportunities and utilisation of human resources more effectively. It could also bring about better usage of goods, services and utilities and correct capacity under-utilisation in trade and commercial ventures. However, the main danger that could transpire could be that an over doze of money supply needs to be cautioned against, since this could step up inflationary trends and its concomitant pressures on the UK economy. Again, should such a situation arise, it would become necessary to hike bank rates and curb spending, including government spending in order to arrest inflationary trends. The Government has pegged the inflation at 2% rates and needs to maintain this target throughout. Tightrope walk countering inflation and need for well judged investments: Thus, the tightrope walk needs to balance, on the one hand, forces of inflation, which reduces the value of the pound and its purchasing power, hikes cost of living and makes product, goods and services scarcer and by effect, dearer. On the other hand, it is necessary to adhere to MPC guidelines on quantitative easing and purchasing assets. This is referred by the writer as tightrope walking since any undue weightage, on one criterion, or measure could put the other factor under pressure and so on. For instance, if the rate of inflation rises above 2% (target rate), anti-inflationary measures need to be put into place, money supply has to be curbed and bank rate increased etc ; similarly, if it falls below 2%, more money has to be flushed in and economy has to be kept buoyant through investments and funds injections. Therefore, the main crux of the issue would be in terms of a constant monitoring and vigil exercised by the MPC, including reacting with alacrity, with appropriate measures to counter price and cost movements. It is perhaps for this reason that the Committee needs to meet regularly to discuss and deliberate on various issues concerning its policies and programmes. Conclusions: The sum total of governments economic policies are net effects and ramifications of a number of issues, inherent, intrinsic and internal. This is more so in the current scenario where recessionary trends have not yet abated, worldwide and its sphere of influence transcends national boundaries. Given the kind of economic position which now surrounds the UK, it would only be a hard core optimist who would dare to suggest that things would look up in the near future, miracles apart. Each passing day also witnesses new challenges and economic pressures whose implication could be more serious that ostensibly believed mores in the current climate surrounding the financial world today. However, when considering the MPC of the Bank of England, it would be injudicious to suggest that the plans and programmes would not bear good tidings in the long run. Te main emphasis that these programmes entail is the stability of the economy in the long run, which perhaps manipulating of bank rate may not achieve. Policy decisions of MPC: However, it would not be imprudent to suggest that each policy decision needs to be thoroughly weighed on the balance scale of practicality and perspicacity before being enforced. This is imperative if the BoE and its progeny, the MPC wishes to seek the protection and greater interests of the common masses for whom they intend to serve. The underlining factor being preservation and pursuance of better stability, all actions and decisions need to sub serve these aims and objectives, and MPC on its part, needs to unconditionally reject action that undermine common objectives and seek to be at peace with the needs and aspirations of the greater part of the British populace. It is only with the common mandate and consensus of economic think tanks and economic theorists, practitioners and intelligentsia, that major headways could be achieved by MPC and the realisation of its cherished objectives. References Bank of England holds interest rate again 2009, Sky News, viewed 19 July 2009, http://news.sky.com/skynews/Home/Business/Bank-Of-England-Interest-Rate-Decision-Cost-Of-Borrowing-Remains-At-Historic-Low-Level/Article/200907215333486?f=rss Minutes of the monetary policy committee meeting 6 and 7 May 2009: the immediate policy decision 2009, Bank of England, viewed 19 July 2009, http://www.bankofengland.co.uk/publications/minutes/mpc/pdf/2009/mpc0905.pdf Monetary policy framework n.d., Bank of England, viewed 19 July 2009, http://www.bankofengland.co.uk/monetarypolicy/framework.htm Review of 2008/09: implementing MPC decisions n.d., Bank of England Annual Report 2009, viewed 19 July 2009, http://www.bankofengland.co.uk/publications/annualreport/2009/review2008-09.pdf Swint, B & Ryan, J 2009, Bank of England cuts rates, says inflation will slow (update8), Bloom Berg.com, viewed 19 July 2009, http://www.bloomberg.com/apps/news?pid=20601087&sid=a3cCk2CGQyWE&refer=home Quantitative easing explained n.d., Bank of England, viewed 19 July 2009, http://www.bankofengland.co.uk/monetarypolicy/assetpurchases.htm Quantitative easing explained: putting more money into our economy to boost spending: supplying more money how it works 1996, viewed 19 July 2009, http://www.bankofengland.co.uk/monetarypolicy/pdf/qe-pamphlet.pdf Read More