The Monetary Policy of the Bank of England - Essay Example

? The Monetary Policy Of The Bank Of England Monetary Policy and how it Functions Economic stability and growth are important macroeconomic goals that must be pursued by all countries. To realize a steady and stable economic growth and development, it is important for the government through its relevant agencies to establish sound and sustainable economic policies. This starts from the macro and the micro levels of the economy (Stationery Office, 2006 p. 34). The economic stability of a country/state depends on the effectiveness of economic policies advanced in order to regulate the fiscal activities within the country and at the international levels. Therefore, to realize economic stability, it is paramount for the economic policies enacted to be in correspondent with the state of the country in terms of resources and economic endowments. Two approaches are used to realize the economic goals of price stability, growth and development, and stability in the exchange rates. These two ways include monetary and fiscal policy mechanisms. While fiscal policy frameworks focus on aspects such as government expenditure, taxation, and subsidies, the monetary policy represents the stipulations enacted to regulate the flow of money in the economy. Besides, the monetary policy mechanisms are used by the financial institutions to regulate an effective interest rate. The main objective of regulating the flow of money in the economy is to stabilize the currency and control inflation within a manageable or planned level. The monetary policy is an effective aspect and framework of the Central Bank of England that impacts on the effective cost of borrowing which has a direct effect on the amount of money in circulation and consumer expenditure. The stability of the monetary policy is measured by the stable prices, stable exchange rates (confidence in the currency), and low inflation rate. All the key decisions regarding the monetary policy are made by the Monetary Policy Committee. MPC of the Bank of England The Bank of England, through its Monetary Policy Committee, attempts to regulate and influence the general economic pattern and expenditure by changing its official interest rates. This is because it is important to maintain a steady growth rate between the level of output and money expenditure in the economy so as to eliminate inflation. Through this approach, the MPC therefore desires to control inflation by adjusting interest rates either upward or downward (Cobham, 2003 p. 61). After setting the national renting rate to major financial institutions, these then affect the entire economy from building societies, trading institutions, to consumers. Besides, the interest rates set by the MPC of the Bank of England is reflected in the exchange rates markets and equity stock markets. The Bank of England's Monetary Policy Committee (MPC) charged with the responsibility of determining the interest rates was accorded the power by the Labor Government in 1997. This followed periods of high inflation rates and soaring bench mark of 15% after it was realized that ministerial interest rate control was ineffective in maintaining long-term sustainable economic stability. This was because the economic decision were clouded by political factors. The MPC of the Bank of England is a nine member committee chaired by the Governor of the Bank of England, the Deputy Governors, four appointees by the Chancellor, Chief Economist, and Executive Directors of the Market Operation. Monetary Policy Statistics (2002-2012) Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 CPI 1.3 1.4 1.4 2.0 2.3 2.3 3.6 2.2 3.3 4.5 2.7 Interests Rates 4.0 3.75 4.75 4.5 5.0 5.5 4.6 0.6 0.5 0.5 0.5 From these statistics, it is observed that the MPC of the Bank of England has been very consistent in its policies and interest rates. From 2002 to 2012, the highest inflation rate ever reported in England wass 4.5% in 2011 while the lowest inflation rate in the economy of England is 1.3% recorded in 2002. However, over this eleven year period, the Monetary Policy Committee has been able to contain the inflation rate within the planned limits except in 2011 when the CPI surpassed the planned level. It is also observed that the CPI has not been very steady as it keeps on fluctuating. Concerning the interest rates or the benchmark, the trend has been declining. In 2007 following the global financial crisis, the benchmark rates was very high at 5.5% making the cost of borrowing expensive and driving out investments. However, the MPC defended their decision of raising the interest rates citing the global financial contagion as being the reason. After the economic stability through financial bailouts to the financially crippled nations, the monetary policy committee reduced the cost of borrowing funds to 0.5% so as to stimulate economic growth and investments. The MPC has since then kept the bank interest rates constant at 0.5%. Evaluation of Monetary Policy Monetary policy is effective in regulating the economic activities of England since interest rates have powerful and direct influence on the consumer expenditures, and indication that the consumption of interest elastic. The Bank of England’s Monetary Policy Committee operates as an independent unit free from any political influence or interference. The interest rates will be adjusted monthly unlike the discretionary fiscal policies which are very static and cannot be adjusted on regular intervals. The effects of changes in the interest rate are immediate as they may be experienced in the economy within a very short period of time unlike the fiscal mechanisms which are often experienced after half a year. Although the monetary policy is effective in delivering the desired results of economic stability within a very short time, the use of interest rate as an economic stabilizer is limited to some extent. Some of the limitations of the monetary policy (interest rate mechanism) include the need for more time lags to observe the full impacts of this policy on the general economy, and the negative implication associated with the interest rate policy. The major weakness of the monetary policy mechanism (where interest rates are preferred as the economic stabilize) is the liquidity trap. At the liquidity trap level, the demand in the money economy is insensitive to any change in the interest rates. At this point, the interest rates are too low to instigate changes in the demand or supply of credits, hence inelastic. The dual-economy where booming sectors of the economy are subjected to higher interest rates while the depressed sectors are stimulated through reduced interest rates is another limitation of monetary policies in the case of England (Dow & Saville, 1988 p. 53). In addition, change in the interest rates negatively affects the BOP (balance of payment) through reduced investment expenditure. The financial speech delivered by Bernanke captures the effect of interest rate on the lending as one of the greater factor in determining the direction of economic cycle for the stipulated period in UK. It is therefore imperative to give it a critical analysis and assess all the possible macroeconomic influences that are responsible for the looming financial crisis in Europe and England in particular. There is call for a new approach towards monetary policies in an attempt to overturn the heavy cost that the crisis will put on UK and the entire Europe by extension. In the speech, Mr. Bernanke talks of Federal Reserve Bank intervention through stimulus injection so that the economy can be salvaged from the looming slump. This would help reduce debt burden besides expanding government expenditure and thereby boosting the overall economy of UK (Alexander, 2008 p. 34). The focal point is to consider the growth target with respect to the global oil prices and exchange rate variations as this is equally important to the monetary authorities of the country. Bernanke proposes other monetary policy measures in form of open market operation in which the government can also boost the overall economic growth through its long term bonds. Unfortunately, it was open that a number UK government’s long term bond yields were at a great low yet they were considered the greatest credit worthy. This sends a wrong signal to the UK rating of the sovereign credit. The trend in the US asset bond sales shed a green light on the overall financial movement of most stock markets across the world including UK. Bernanke gives hope concerning the level of expected economic growth though he points out some influence from the international macroeconomic factors that are led by the oil prices. The major concern that needs to be solved for any reasonable economic growth at the projected annual rate of about 7% is the issue of employment. He is quick to highlight the effect of unemployment which results from dwindling financial market driving some people out of business thereby raising the level of retrenchment (Bofinger, Reischle & Scha?Chter, 2011, p. 45). The unemployment rate should be narrowed down so that the national income can go up through the multiplier effect and this is only possible if the Bank of England comes up with strategic policies that would inject finance into the economy. The best approach for this is to promote economic stimulus through the expansionary policies of Federal Open Market Committee’s (FOMC). Open market operation would help in regulating the amount of money in supply to ensure that there are constant prices as this is important in controlling inflation rates and defining the labor market wage prices. There is need to increase government spending which can be initiated by borrowing such that more people would be absorbed into jobs created through the government expenditure multiplier. According to Bernanke, Federal Open Market Committee’s (FOMC) has been making a move towards increased purchase of mortgage assets from the public as a tool for increasing its financial base which would then make the economy expand in terms of expenditure and significantly raise the national income bar with regulated prices so that inflation is subdued. Interest rate on borrowing of capital assets is another tool at the disposal of the Bank of England. This is a very vital player when it comes to regulation of the income level in the economy since it influences saving and investments. It is important to underline the relationship that exists between the borrowing rates and the subsequent financial and economic trend. The Bank of England needs to keep the borrowing rate low to increase the acquisition of financial assets with the effect of expansion in labor demand for the investors. This will in turn reduce the unemployment rate and keep the economic growth steadily up the ladder. This will have the effect of suppressing the unemployment rate at its 6% threshold with a long term projection of keeping the inflation rate at its low of 2% as projected by the Bank of England Authorities. A balance between the inflationary pressure and unemployment is only sustainable through proper regulation of the labor market and the general price levels. Interest rate inelasticity is vital in dictating the stability of the economic performance of the economy since this is likely to weed out cases of speculation among investors using the market volatility condition (Sollis, 2012 p. 53). This is equally important in stabilizing exchange rate which will greatly influence its local and international economic performance thereby sustaining the balance of payment at its current position. The Bank authorities need to stick to accommodation for some time to ensure that there is stability in prices, hence, possibility of meeting the projected target of the economy. Bernanke’s speech explores the inherent relationship that exists among the various macroeconomic variables in any economy. It is important to underline the pivotal role of interest rate, employment rate, price level, exchange rate among others in explaining the economic trend across the world. He emphasizes on the inflation rate and the employment rate in moderation of the economic performance. The role of expansionary government policy through increased government expenditure is important for the survival of the economy. He relates the economy of the US as being very vital when it comes to the economic performance of other countries since the dollar is the global monetary unit of exchange. Stringent monetary policies that regulate the supply of money in the economy are one of the greatest regulatory tools for achieving desirable economic goals and surviving the rough disturbance from external effects of other nation’s economy. This speech forms an important reference point on what the Bank of England need to adopt in the interest of its economic survival. Bibliography Alexander, C. 2008. Market Risk Analysis: Pricing, Hedging and Trading Financial Instruments. New York, John Wiley & Sons. Bofinger, P., Reischle, J., & Scha?Chter, A. 2011. Monetary policy: goals, institutions, strategies, and instruments. Oxford [u.a.], Oxford Univ. Press. Cobham, D. 2003. The Making of Monetary Policy in the UK, 1975-2008. Chichester, John Wiley & Sons. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=141616. Dow, J. C. R., & Saville, I. D. 1988. A critique of monetary policy: theory and British experience. Oxford, Clarendon Press. Stationery Office, 2006. Bank of England Monetary Policy Committee: appointment hearing for Professor David Blanchflower: eighth report of Session 2005-06. London, Stationery Office. Sollis, R. 2012. Empirical finance: for finance and banking. Chichester, West Sussex, Wiley. Read More