The Effectiveness of The Bank of England Policies in Overcoming the Crisis - Essay Example

Applied economics on the bank of England Introduction The central banks of different countries are charged with the responsibility of financial regulation, which also entails the aspect of maintaining the financial stability of a country. The case is the same for the Bank of England (BoE), which acts as the central bank in the UK, thus playing the vital role of regulating the financial operations of the UK, with a view to maintaining financial stability within the UK economy (Dow, Taylor, & Hacche, 2013 p16). To achieve this, the Bank of England is tasked with the responsibility of ensuring that the inflation rates in the UK economy does not surpass the higher or the lower limits, to avoid a situation where the economy could be adversely affected. The vigilance role of the Bank of England was affirmed even more, after the global financial crisis of 2007-2008, where many countries were adversely affected by the inflation rates, which threatened to collapse the economies of major countries in the world (Great Britain, 2005 p5). This led to the establishment of major changes in the Bank of England, with the most significant being the establishment of the independent Financial Policy Committee (FPC), which was mandated to work as a subsidiary of the BoE, to supervise the financial markets, and implement the financial regulation mechanisms, to enhance the stability of the UK financial markets (Dow, Taylor, & Hacche, 2013 p17). At this point it becomes necessary to pose the question: Just how do the Bank of England, and its subsequent subsidiary formation; the Financial Policy Committee (FPC) regulates the financial stability of the UK economy? Thus, this discussion seeks to explain how the Bank of England tries to manage inflation, with a focus on whether the Quantitative Easing Programme, which is among the mechanisms applied by the bank to stabilize the economy, may cause higher inflation in future. Discussion How the Bank of England tries to manage inflation The concept of inflation refers to a situation where there is a general rise in the prices of goods and services in an economy, within a specified period of time (Heffernan, 2005 p34). Thus to address this general rise in the prices of goods and services in the economy, it become essential for the Bank of England to apply certain measures, which can help to bring the prices down, and thus stabilize the economy. In doing this, the Bank of England applies various mechanisms, which include: Monetary policy This refers to a mechanism applied to reduce the inflation rate, through the Bank of England introducing a period of higher interest rates, which targets to reduce both the consumer and the investment spending in the economy, and thus lower the quantity of money that is circulating in the economy (Griffiths & Wall, 2007 p22). This way, the general prices of goods and services in the economy will be lowered, considering that there would be less money in the economy, which cannot support the higher prices. The change of the official interest rate by the Bank of England is applied in the situation where the amount of money that is being spent in the economy has grown at a higher rate, compared to the volume of the output produced, in terms of the goods and services (Qfinance, 2009 p249). Thus, the Bank of England sets an interest rate, at which it lends to the other financial institutions within the UK, which in turn affects the interest rates at which such financial institutions, which include the commercial banks, the building societies or the insurance companies, will attach to their loans and mortgages, which they advance to their customers. In addition, the change in the interest rates also affects the prices of other financial assets such as the shares and the bonds, while also influencing the exchange of the country’s currency against those of other countries (Mishkin, 2010, p77). All these changes serve to influence the demand by consumers and businesses, thus affecting the spending that such consumers and businesses make in the economy. On the event that the Bank of England reduces the interest rates, spending in the economy is increased, and the consequent amount of money circulating in the economy increased. On the other hand, when the Bank of England increases the interest rates, the ability of consumers and investors to spend in the economy is decreased, thus lowering the amount of money circulating in the economy (Rothbard, 2008 p12). This is so because, when the interest rates are increased by the Bank of England, the consequent interest rates charged by the other financial institutions to their customers increases, thus making borrowing less attractive, and thus lowering the ability of the consumers and businesses to spend in the economy (United Nations, 2010 p114). On the other hand, where the interest rate is lowered by the Bank of England, the rates charged by the other financial institutions to their customers also reduces, thus making borrowing more attractive to the consumers and investors, and thus making it possible for them to increase their spending in the economy. Quantitative Easing mechanism This is yet another strategy that is applied by the Bank of England to manage the inflation rate within the UK economy. The Quantitative Easing mechanism is an unconventional method of managing inflation, which is applied under circumstances where the monetary policy does not seem to generate the desired effect, in enhancing the stability of the economy (United Nations, 2010 p114). Quantitative Easing is a mechanism that entails the injection of money directly into the economy by the Bank of England, where there is no enough money circulating in the economy (Buckley & Desai, 2011 p52). This situation can arise where the businesses and the consumers demand has greatly reduced, making their spending too low to support the economy. Thus, the Quantitative Easing mechanism is applied as an alternative to supplement the normal monetary policy, where the monetary policy has been unable to produce the desired effect (Chadha & Holly, 2012 p245). The monetary policy may fail to produce the desire effects due to the fact that there is a great time lag between the implementation of the change in interest rates, and the actual decision making by the businesses and the consumers, which in turn affects the consumer prices. Therefore, Quantitative Easing mechanism is adopted especially where the inflation rate, as adjusted through the monetary policy is approaching zero, and thus it should not be reduced further. This paves way for the direct injection of money into the economy, meant to increase the money supply through flooding the financial institutions with capital and money for lending, to stimulate spending in the economy, without paying any particular attention to the interest rates (Ciro, 2012 p122). When the financial institutions are given more money directly, they increase their lending to the businesses and consumers through making their lending terms more flexible, enabling the borrowers to borrow frequently and in huge amounts. This in turn enhances the ability of the investors and the consumers to spend in the economy, thus stimulating production and reviving the economy (Great Britain, 2005 p7). Whether the Quantitative Easing Programme may cause higher inflation in future While the Quantitative Easing mechanism, as used by the Bank of England to increase the supply of money in the economy and thus stimulate spending is beneficial in regulating the financial conditions of the economy, thus enhancing financial stability, there are chances that the concept may increase inflation in the future. This is possible due to the following: Capital flight This is one of the major dangers associated with the Quantitative Easing mechanism, which sets the stage for future inflation rise in the economy. Capital flight refers to a situation where the commercial banks and other financial institution applies the money given to them by the Bank of England through the Quantitative Easing programme, to invest in other assets and properties, at the expense of advancing the same to the borrowers as loans (Michael, Miles, Scott & Vayanos, 2012 p272). The implication of this is that; the money introduced into the economy is further locked up in the banks’ solid investment, at the expense of being allowed to circulate into the economy. This in turn reduces the money supply in the economy, thus increasing the general price levels for goods and services, which is a component of high inflation in the future (Wade & Bilson, 2012 p2). More money floating Vs a fixed amount of goods in the economy The Quantitative Easing mechanism is a measure to manage inflation applied by the Bank Of England, through buying government securities or other private securities from the market, with the aim of flooding the market with more money, meant to stimulate economic activities through availing money to be spent in the economy by both businesses and investors (O. E. C. D., 2013 p86). However, while opening the floodgates for money to flow into the economy, the Quantitative Easing mechanism does not affect the interest rates. This means that the quantity of goods and services available in the economy remains fixed, while the money supply has increased, setting a stage for a general increase in the prices of goods and services (Silvia, 2011 p238). This means that the rate of inflation is set to increase even further, in the future. Conclusion The Bank of England (BoE) is the institution tasked with the responsibility of overseeing financial regulations, to enhance the financial stability of the UK economy. It is assisted in this role by a subsidiary independent body, Financial Policy Committee (FPC), which is mandated to supervise the financial markets, and implement the financial regulation mechanisms. The BOE applies both monetary policy and Quantitative Easing mechanism as the inflation management tools, to ensure that the inflation level does not surpass the lower or the higher limits as predetermined. While the monetary policy mechanism is effective in addressing the issue, it takes long before its impact is felt on the prices of commodities, which may at times necessitate the application of Quantitative Easing mechanism as supplementary mechanism. However, the risks associated with this mechanism is its potential to cause future inflation, through capital flights and the stagnancy of production of goods and services, since the mechanism does not affect the interest rates, which in turn determines the production in the economy. References Buckley, G., & Desai, S. (2011), What you need to know about economics, Chichester, West Sussex: Capstone. Capie, F. (2010), The Bank of England: 1950s to 1979, New York: Cambridge University Press. 651 Chadha, J., & Holly, S. (2012). Interest rates, prices and liquidity: Lessons from the financial crisis. Cambridge: Cambridge University Press. Ciro, T. (2012), The Global Financial Crisis: Triggers Responses and Aftermath, Ashgate Publishing, Ltd. Dow, J., Taylor, C. T., & Hacche, G. (2013), Inside the Bank of England: Memoirs of Christopher Dow, chief economist, 1973-84, Basingstoke: Palgrave Macmillan. 16 Great Britain. 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