Monetary Policy of the UK - Essay Example

UK monetary policy Monetary policy entails changes in the rate of interest with the aim of influencing the rate of growth in demand, price inflation and money supply. Economists believe that monetary policy is a better weapon in controlling inflation than fiscal policy (OECD 2009). Monetary policy also involves controlling the changes in the value of exchange rate. This is because currency fluctuations affect the macroeconomic activity in a country. According to the international monetary fund, the bank of England appears to be nimble when it comes to easing the monetary policy in the United Kingdom. United Kingdom has been working hard to recover from recession and support growth over the last few years. The policy mix has been of help in rebalancing the United Kingdom economy from recession toward external demand and investment. The government of United Kingdom has been implementing a strong fiscal consolidation with the aim of reducing budgetary risks. This paper focuses on the UK recession and the role played by the impact of the monetary policy in economic recovery. The United Kingdom has the chance to reduce the interest rates that have been set by the central bank now that the inflation seems to be well anchored (UK Parliament 2012). This is meant to create room for money to be injected into the economy. Consumer and business confidence in the United Kingdom remains weak even after the effort to rebalance the economy in the UK. The economic recovery has been supported by an emphasis on strengthening the bank balance sheet (Giudice & Kuenzel 2012). This has been done though building capital as opposed to reducing the assets (Allen 2012). The government of United Kingdom has adopted measures to ease credit acquisition (Holley 2012). The government is keen in eliminating constraints for both small and medium sized households and enterprises. The government has gone further to boost credit for infrastructure, business and housing (Duthel 2011). The reluctance to clear the government deficits and debts this year is understandable given the sluggish rate of growth of the United Kingdom economy (Giudice & Kuenzel 2012). Restraining the public employee wages has been a move by the government to lessen the effect of reducing deficits and debts to create the process conducive for economic growth (Allen 2012). The government intends to have space for added spending on infrastructure. Additional monetary stimulus should be considered if growth would not get the intended momentum. The government should also consider easing credit in that case (UK Parliament 2012). Over the last few years, the rebuilding of banks capital has been taking place in the United Kingdom. This has been of much help given the amount of risks arising from the euro zone economic crunch and the consequent volatile financial market. The government of United Kingdom has embarked on raising banks capital (Duthel 2011). The government also advocated for a limitation in bonus payouts and dividends. This is contrary to selling assets. The move has paid off through a substantial economic recovery. According to international monetary fund, high level and quality supervision is vital for the growth of economy and establishment of the incoming government structure that is supposed to oversee the financial system of the United Kingdom. The government has enhanced supervision of financial institutions that are considered crucial for economic recovery (Holley 2012). United Kingdom has embarked on a robust regulation and development policies for raising capital and financial oversight duties (IME 2012). The recent United Kingdom economic crisis has posed extreme difficulties to the economic policies. Growth is considered anemic after deep recession (Giudice & Kuenzel 2012). The government of the United Kingdom remains extremely concerned about fiscal sustainability. The government is faced by a fast increasing public debt and large deficits compared to the ratio of gross domestic products (GDP) (Joyce & Miles 2012). It seems difficult to make use of monetary policy with the goal of stimulating growth. Offsetting the fiscal stringency has been a challenge (Duthel 2011). This has been occasioned by lessening of the scope for reduction in the interest rate. The impact of transitory value added tax has caused the inflation to be above the target set by the bank of England. Besides, the economic growth has been weak. Until the second quarter of the year, the retail numbers in the United Kingdom were low (Joyce & Miles 2012). During the recession, the key challenge that faced monetary policy makers was the way of coming up with monetary policy that radically addresses the current economic crises (Duthel 2011). The rise in commodity prices and global energy has caused increased inflation and slow economic growth in the United Kingdom. The monetary policy makers had to come up with urgent ways of dealing with the rising inflation and increased food prices (Holley 2012). The monetary policy committee of the bank of England conducts the United Kingdom’s monetary policy. The economy of United Kingdom has avoided falling to double dip recession though a narrow margin (Giudice & Kuenzel 2012). The manufacturing slump in the country was responsible for the fragile resurgence. The market developed by 0.10 per cent during initial section of 2012. Observations from the state-run institution of monetary together with public Research (NESR) indicates that, notable growth can be experienced (Allen 2012). The hope that manufacturing would drive and sustain the economic recovery was beginning to decline. According to ONS, the industrial sector performed well in February because of the weather boosted electricity, oil and gas demand. The output of the industry rose by 0.1 per cent which indicated it surpassed the forecast (Joyce & Miles 2012). For sustainable growth to be achieved, other viable policy aspects must be drawn. The structural changes are known to affect industrial shakeups (Holley 2012). Resources should be drawn from the poorly performing sectors into the vibrant and long term drivers (IME 2012). On the eve of 2007 and 2008 financial crisis, the empirical and intellectual strength of the foundations of the United Kingdom monetary policy seemed strong and robust (Giudice & Kuenzel 2012). The main aim of the monetary policy was to get stable inflation and low inflation rates. The framework of the policy was targeting inflation (Holley 2012). The government was using the short term interest rate. The intention was to get the central bank provide money to banks and the interbank market. This proved to be helpful in the lying the foundation for the United Kingdom economic recovery (Allen 2012). The impact of these policies was not felt as soon as expected, but it was reliably quantified. Under this framework, the interest rates were set after sound judgment. A wide range of macroeconomic observations were observed consistent with the Taylor rules approximations. The interest rates were seen to respond to changes in inflation and the output gap fluctuations. This reflected the functional summary of conventional monetary policy that is practiced in the full-grown economies (Giudice & Kuenzel 2012). These measures led to a predictable and effective use of monetary policy and a triumphant pursuit of low inflation rates (Duthel 2011). The economic crises happening in the United Kingdom and its consequences can be termed as the worst since the 1930s. It has posed a variety of challenges in central banks and monetary policy. The conventional monetary policy in the United Kingdom did not prevent assets market fears from occurring, but it was instrumental in achieving stable and low inflation (GB Treasury 2010). An observation made at the time revealed that the major aim of monetary policy in the United Kingdom was to check the rates of inflation (Allen 2012). The observation suggested that it was effective and better to use the United Kingdom monetary policy to mop the consequences of the burst bubble than to take the buildup of the same (Holley 2012). The monetary policy was effective is strengthening the fundamentals of the United Kingdom’s economy and preventing further recession (UK Parliament 2012). The major aspects of the economy were stagnation partly because of pressure from a receding world economy and the economic crises in the euro zone (Collins 2012). The central bank seems to have a keen focus on the financial stability besides controlling inflation. According to Tinbergen’s Law, an authority that has N policy goals or targets required at least N policy instruments. In the United Kingdom, a finance policy committee was created to run and oversee macro prudent policy together with the monetary policy committee. The government of United Kingdom was keen of developing the capacity of the institutions that were directly involved in the economic recovery and that paid off eventually (IME 2012). The central bank augmented its arsenal of policy instruments with all the available macroprudential tools. The Basel III was useful in strengthening the liquidity rules and capital adequacy (GB Treasury 2010). These policies helped in restoring the financial stability of in the United Kingdom and preventing the bubbles of asset market (Holley 2012). Conventional monetary policy was influential in mopping up the consequences of financial crisis and in the stimulation of the UK economy into a sustainable recovery venture. The economy is out of recession, but the market fear still remains. The economy is slow compared to forecasts causing the critics to accuse the United Kingdom monetary policy makers of being overly optimistic (Duthel 2011). The economic growth of 0.1 per cent in the first quarter was encouraging but not sufficient. The depth of the United Kingdom recession meant that the Taylor rules would suggest nominal rates, which are negative. However, market rates seem to be effectively bounded by close to zero. The main reason for this is that agents can put up with bearing cash without any interest (Holley 2012). When the central bank interest rates go to zero or close to zero, other monetary policies need to be put into view. The recession disrupted the financial system of the United Kingdom. The solvency of many banks in the United Kingdom started being questioned (Allen 2012). The consequences of the bubble bursting caused the healthy relationship between the market interest rates and the central bank interest rates to be profoundly affected. The central banks were caused to consider interventions that would salvage the economic situation in the United Kingdom (Giudice & Kuenzel 2012). The process of economic recovery in the United Kingdom has been a tough balancing act. It entailed tough and firm measures from the central bank and strict market interest rates enforcement. Banks were tempted to fight for their survival in a straining economy and opted to hold on to funds to ensure their own viability (Collins 2012). The prompted the central bank to intervene to facilitate direct provision of credit to the private sector. The aim was to strengthen small and middle class enterprises that can lead to economic expansion through reduction of the rate unemployment which stood at over 8 per cent (IME 2012). The UK monetary policy makers believed that building capital is a better way to enhance economic recovery than selling assets (UK Parliament 2012).   Profile of recession and recovery in the United Kingdom Figure 1. The policy makers had to strain with the challenge of enforcing strict measures, which were intended to help the economic recovery (Joyce & Miles 2012). This is because of the realization that appropriate policies could not work without strict compliance (Giudice & Kuenzel 2012). The reports from purchasing managers index indicated that there was a pick up in the first quarter this year. This is what prompted some economist to predict a 0.5 per cent economic growth in the first quarter GDP predictions (IME 2012). This is a positive change compared to 0.3 per cent decline by the end of last year (Allen 2012). The organization of manufacturers had the opinion that growth was to be expected in manufacturing center during the first quarter. Moreover, the organization said it expected an overall economic growth. However, their statement indicated that any economic growth could not be taken for granted and that the economic recovery journey of the United Kingdom still faced extreme challenges (Collins 2012). According to Andrew Johnson, an EET economist, the economic crisis in Europe posed a significant challenge in the recovery of the United Kingdom’s economy. The outlook of the UK economy seemed volatile. The economists in the country are divided on whether the money printing program by the bank of England should be expanded. That move is referred to as quantitative easing (QE). However, the conventional monetary policy has proved that it was not as effective as expected. The impact of the Taylors rule on the market rates was not as fast as expected (Collins 2012). At the same time, the central bank was under pressure to perform and was looking monetary policies whose impact would be felt with immediate effect. This proved to be a monumental challenge to the monetary policy makers in the United Kingdom (Allen 2012). The immediate desire from the central bank was that the convectional monetary policies would work. The impact of the macro prudential tools would be influential in achieving the financial stability. With their plan appearing to slower than expected, the central bank of England was forced to use uncongenial monetary policy (Holley 2012). The highest form of unconventional monetary policy used in the United Kingdom has been the quantitative easing (QE). This phrase was introduced with an aim of signaling a shift in focus to targeting quantity variables. The phrase was first applied in Japan to deal this the real estate bubble and the pressures from deflation (Giudice & Kuenzel 2012). The United Kingdom and the United States followed Japan in embracing the policy and the result has been an increase in the balance sheet of the central bank (IME 2012). Through quantitative easing, the bank of England has bought the United Kingdom’s government bonds overwhelmingly (Holley 2012). This has been done through engaging the non-bank private sector with the buying process. The Fed in the United States bought treasuries and other agency debt securities. This means that there were minor differences in the implementation of quantitative easing between Japan and the United Kingdom (IME 2012). The Fed and the bank of England asset purchase were designed to affect the yields over a wide range of assets. The objective of the central bank has been to control the prices of the assets in the private sector (GB Treasury 2010). The efficacy of unconventional monetary policy has been a subject of much interest to the central bank of England. This is because the conventional monetary policy is perceived to be firmly built on a theoretical base (Allen 2012). According to Woodford, conventional monetary policy may be irrelevant when it comes to their practicality on the ground. However, it becomes difficult to assess the impacts of unconventional monetary policy on economic recovery primarily because they are developed as a response to a situation as opposed to an intellectual development or drive (Giudice & Kuenzel 2012). This has been the situation in the recovery process in the United Kingdom (GB Treasury 2010). A clear framework of the impact of the unconventional monetary policy lacks in the process of economic recovery of the United Kingdom (Collins 2012). However, the unconventional monetary policy applied in the United Kingdom has an impact in the macroeconomics (UK Parliament 2012). In conclusion, the process of economic recovery in the United Kingdom has been a combination of conventional and unconventional monetary policies. The centrol bank of England has been applying the conventional monetary policies like checking the interest rates in the bank and regulating the market interest rates. The bank has encouraged the issuing of easy credit with an aim of building capital. At the same time, policy makers are assuring commercial banks that their confidence in low-interest proposals from the central bank shall bear fruit eventually. The main target has been to reduce inflation and encourage growth through developing small enterprises. Research shows that it is not always possible to assess the direct and immediate impact of interest rates in the market or economic recovery. The conventional monetary policies have not been as fast as anticipated. This has caused the bank to incorporate unconventional monetary policies with hasten economic growth. In the final analysis, the strategy has worked and the economy of United Kingdom in officially out of recession. However, the growth is still vulnerable and requires strict observation. Appendices: Figure 1 is a graph showing UK recessions and the recovery trends over the years including the current situation. References Allen, K. 2012, April 5. UK economy grew 0.1% to avoid recession, says NIESR. The guardian, p. 5. Collins, M. 2012. Money and Banking in the UK (RLE: Banking & Finance: A History 1st ed. Routledge. Duthel, H. 2011. European Debt Crisis 2011 1st ed. epubli. GB Treasury 2010. Budget 2010: securing the recovery, economic and fiscal strategy report and financial statement and budget report 1st ed. The Stationery Office. Giudice, G., & Kuenzel, R. 2012. UK Economy: The Crisis in Perspective 1st ed. Routledge. Holley, D. 2012. UK Economic Recovery: The Long Road: A Political Thesis (1st ed.). Grosvenor House Publishing Limited. IME 2012. Profile of Recession and Recovery. Institute for Market Economics. Retrieved November 23, 2012, from http://http://ime.bg/en/articles/profile-of-recession-and-recovery/ Joyce, M., & Miles, D. 2012. Quantitative Easing and Unconventional Monetary Policy – an Introduction. The Economic Journal, 122 564 F271–F288. OECD 2009. OECD Economic Surveys: United Kingdom 2009 1st ed. OECD Publishing. UK Parliament 2012. Economic and fiscal outlook March 2012 1st ed. The Stationery Office. Read More