Effects of Assets Purchases by Bank of England on British Economy - Essay Example

Effects of Assets Purchases by Bank of England on British Economy number Lecturer Introduction Inflation is the situation in which, the price of assets in the economy goes up over time. In United Kingdom, the central bank anticipates the price of assets to continue growing at an average of two percent each year (Quantitative Easing Explained Pamphlet, p.7). This means that, after every fifty years the central bank of England anticipates the value of the economic assets to double. The growth in value of resources is in relation to the value of money in distribution. Availability of funds for use in the economy influences spending and saving patterns by the individuals and organizations (Joyce, et.al. 2011, p.204. The central bank of England has a duty to regulate the amount of money in the economy through various instruments at its disposal hence stabilizing economic inflation. These strategies are used by the central bank of England to control the rate of inflation, either by encouraging the public to spend more, or lowering their spending rate depending on the prevailing economic conditions (Joyce, et.al. 2010, p. 176). Central bank applies both conventional and unconventional strategies to regulate the rate of inflation in United Kingdom. In order for the central bank to plan the means they will use to manipulate the rate of inflation in the economy effectively, they should be able to predict the trend of economic advancement at least two years in advance. When the central bank of England increases the amount of money in circulation, they encourage public to spend more, thus pushing the rate of inflation high (Benford.et.al, 2009, p.48). If the central bank decreases the amount of money in circulation, they will discourage people to spend more hence reduce the rate of inflation. Asset Purchases financed by Central Bank Money: Quantitative Easing High inflation results to overspending by both individuals and business. This results to decline in saving power of the consumers (Benford.et.al, 2009, p.47). It also affects the lending power of the financial institutions. The central bank of England has mandate to regulate the rate of inflation of the country by playing around with the interests which they charge the financial institutions. During the time of high inflation, the central bank of England will increase the interest rates of the lenders. This high interest rate has an effect of reducing the lending rate so as to lower the rate of spending. The central aims to achieve this by discouraging borrowers from acquiring expensive loans. As the individuals and businesses borrow fewer funds from the financial institutions, the money in circulation reduces thus lowering the value of properties. If the central bank notice the money in circulation is limited, they can lower the level of interest rates for the lending institutions (Joyce, et.al. 2011, p.208). These lending institutions will release more money to the borrowers. This is because low cost of capital will attract more borrowers to acquire more money to invest in different sectors of the economy. As individuals and businesses borrow more funds from the lending institutions, this increases the money in circulation. This increases both spending and saving ability of the individuals and businesses. Implementation of the Quantitative Easing In case the rate of inflation goes below two percent, the fund available for spending and investment goes down resulting to decline in prices of the assets. The central Bank of England will introduce more funds to increase the level of inflation up to two percent. The central bank of England increases the money in circulation through direct purchases of properties from private investors. When these private investors sell their properties to the central bank, the money which was held by the central bank is now made available for spending by the private bodies. For example in 2008, there was a shortage of money in circulation in United Kingdom. The rate of inflation fell below two percent. The central bank reacted by purchasing private properties. They bought the government bonds and high value debts offered by the private companies. The effect of this decision was an increase in funds to the public which helped to increase the rate of inflation. When consumers have more money in their pockets, they can buy different consumer goods, thereby increasing the amount of money in flow. Alternatively, the sellers of the properties can use the money they acquired from the sale to buy different properties thereby increasing the flow of funds in the economy. Motivation of Central bank of England to implement Quantitative Easing The target of central bank in regulating the amount of funds in circulation is aimed at influencing the desire of the public either to spend or borrow funds from the lenders. As more consumers make purchases for various items, the prices of these items go up (Joyce, et.al. 2010, p.161). This will result to decrease in lending rates and will attract more borrowers and the cycle continues. The banking institutions will maintain vast funds which they may continue lending to the borrowers to increase the amount of money in flow. Therefore, during the 2008 inflation in United Kingdom the central bank of England reacted by purchasing the “government and corporate bonds” as a strategy of increasing the amount of money available for the public (Joyce, et.al. 2011, p.203). This had an effect of increasing the prices of those financial instruments and in turn resulted to increase in inflation as more money was available in the economy for spending. Unconventional Measures Central bank use different tools to evaluate the impact of strategies used to influence the rate of flow of funds in the economy. They examine the level in which financial institutions have adhered to the central bank regulations (Quantitative Easing Explained Pamphlet, p.9). For example, when central bank declines the interest rate for the lenders, they can monitor the rate at which these financial institutions are lending to the borrowers. If banking institutions reduce charges for the loans and other requirements, this will increase the rate of borrowing and will result to increase in the amount of funds circulating in the economy. The central bank will also monitor the reports regarding changes in value of the commodities. Increase in prices of trade commodities in the market depicts an increase in inflation and is an indicator of the impact of central bank strategies aimed at influencing the rate of inflation. Therefore, the aim of central bank of England is to maintain the inflation rate at two percent. Conventional and unconventional When the rate of inflation is below or above the standard level of two percent set by the central bank, the central bank reacts by imposing measures to reduce or to increase the rate of inflation in the economy. High inflation rate encourages saving while it discourages spending. Low inflation rates on the other hand encourages spending and discourages saving. The central bank influences the rate of inflation in the economy by varying monetary regulations by actively getting involved in trading activities to reduce or increase the amount of money in circulation from time to time. The 2008 financial crisis in England resulted to shortage of cash in circulation hence; there was no money for the investors to spend (Quantitative Easing Explained Pamphlet, p.3). The central bank of England reacted by purchasing thirty percent of private financial instruments. This action resulted to increase in money for consumers and savers. This money could be used for purchasing consumer goods or other assets in the economy. The central bank reduced interest rate, which banks and other financial institutions levied on loans advanced to individuals or businesses (Joyce, et.al. 2011, p.211). The effect of this move by central bank of England was that many people were able to access credit facilities from the lenders. The need for borrowing increased thus making more funds available in the economy. The inflation rate which had gone below two percent was increased by increase in flow of funds in the economy. Transmission channels for assets purchases The approach by the central bank of England to purchase the financial instruments was to increase the money in flow (Joyce.et.al, 2010, 146). The plan was to increase the saving power of the public and raising the inflation rate a desired level of two percent. The value of the assets went up thus discouraging borrowers from seeking financial help from the lenders. Policy signaling effects: initially, the borrowers and lenders of finances in United Kingdom expected the price of the assets to remain low and the interest levies by the lenders to remain high (Quantitative Easing Explained Pamphlet, p.4). However, the decision by the central bank to buy assets influenced the financial sector regulations, which resulted to decrease in value of credits facilities and increase in the price of the commodities. Portfolio balance: the decision by the central bank of England to purchase properties from the private owners in United Kingdom resulted to increase in funds held by the public (Joyce, et.al. 2010, p.141). As a result, the public could use this amount of money to purchase other assets and replace those which they had sold. As more investors continue to buy different properties, their prices continues to hike until such a point when the investors anticipated value of the assets bought equals the value of cash money held by the potential investors. At this point, there will be no motivation for investing due to risk associated with investment and anticipated low returns. On the other hand, as prices of the properties continue to increase, those who held them gain more returns from their sales. This results to increase in money in circulation as property owners have more income to spend than when their prices were low. Liquidity premia effects: if the market activities were stagnant, the central bank can stir up trading activities of the market through their own purchasing activities. This will result to increase in prices of the assets in the society (Quantitative Easing Explained Pamphlet, p.8). For example, in 2008 the trading activities had slowed almost to a standstill in United Kingdom before the Central bank reacted by purchasing the private property directly from the public. Confidence effects: many people prefer to keep their money instead of buying assets if they anticipate the price of the assets to continue declining. This occurs during the period in which inflation is declining, such as the one which occurred in 2008 in United Kingdom (Quantitative Easing Explained Pamphlet, p.11). However, when central bank decides to purchase assets, they motivate individuals to purchase the properties rather than keeping cash money, because they anticipate the value of the assets to increase in future. Bank lending effects: If central bank of England buys assets from the non-bank institutions, these institutions will deposit the cash they raised from sales to the banking institutions. Consequently, banking institutions will increase cash deposits collected from the public. The bank institutions will have more cash to advance to the borrowers. As banks make lending to the public, this will result to more cash circulation in the economy of United Kingdom due to increase in lending. The public will also increase their spending and savings in the other sectors of the economy. This will have overall effects of increasing inflation rate in the economy (Benford.et.al, 2009, p.49). However, the banking system was under pressure from the central bank to reduce their savings and increase money in circulation. Therefore, due to this condition in United Kingdom, the bank lending effects process did not have positive impact in the economy. Quantitative easing transmission channel; Source: Joyce, et.al. 2011, p.201 In conclusion, the central bank of England has a task of varying the rate of inflation in the nation. The most effective ways to achieve this goal is by setting regulations to guide the financial institutions especially in relation to charge rates and other lending environment. Tough conditions limit the borrowers from assessing credit facilities thus leading to low funds circulation in the economy. The other method used by the central bank to regulate the rate of inflation in the economy is through direct purchase of assets from the public (Joyce.et.al, 2010, 134). When the central bank makes purchases, they increase the amount of money in circulation thus expanding the lending and borrowing potential of the financial institutions. This also increases the power of members of the public to spend and invest their excess funds thus increasing inflation rate. Bibliography Benford. J., Berry. S., Nikolov. K., Young. C. Quantitative Easing. Bank of England Quarterly Bulletin 2009 Q2. Warren, E. 2010. Global Context and International Effects of the TARP. DIANE Publishing. Pp.47-50 Joyce, M., Tong, M. and Woods, R. 2011. The United Kingdom’s Quantitative Easing Policy: Design, Operation and Impact. Quarterly Bulletin, 2011 Q3, pp.200-211 Joyce. M., Lasaosa. A., Stevens. I,. Tong. M., 2010. The Financial Market Impact of Quantitative Easing. Bank of England. Working Paper No. 393. OECD Economic Outlook, Volume 2010 (2). OECD Publishing, 2011. Pp.344 Quantitative Easing Explained Pamphlet: Putting More Money Into Our Economy To Boost Spending. Bank of England. Pp.2-14 Read More