Money crisis in UK can be controlled by the Bank of England through changing the interest rate while attempting to alter the level of economic activity. Actions can be taken when the money in circulation increases in fast rate as compared to the output volume produced. This situation can be referred to as inflation. To control this situation, interest rates should be changed. The Bank of England uses monetary policy to increase or decrease the money in the banking system. However, the Bank of England does not print more money to alter money supply as this is against the move by the Federal Reserve Board to print more currency to facilitate the deficit in increasing the economy.
The mechanism for the transmission of the monetary policy depends on the time tags as well as interest demand that could be elastics for the services or goods. Therefore, due to the time tags, the Bank of England usually sets the interest rates on the basis of the targeted inflation for a period of two forecasted period. Again, it should be understood that exchange rate could be one of the ways to deal with the problem; however, this mechanism for exchange rate is no longer in use since 1992. This leaves the bank to work on its interest rates that would affect supply as well as demand of the currency in foreign exchange market rates. Therefore, the Bank of England, while dealing with the money supply to the investors, works with quantitative easing in controlling bank growth, in consumer and lending systems.
First, the Bank of England affects the interest rates through an everyday intervention in the money markets in London. Mostly, a lot of money flows to the government from the banks. For instance, people as well as organizations pay taxes thus there is always a shortage of the money within the money market. The Bank of England acts as the main liquidity provider to the other finance systems within the markets, a situation that is referred to as “lender of last resort.” This provides this main bank with the opportunity to choose certain interest rate that wants to charge other financial systems or institutions need money (Lavington, 2013). Therefore, that interest rate through which BOE ascertains to lend to the other financial system can be passed on quickly, thus affecting interest rates within the economy of United Kingdom.
A good example is the rate of interest charged on mortgages as well as the rates of interest that are on offer to other savers within the country. The interventions can be referred to as ‘open market operations.’ These open market operations can be explained as certain situations through which the Bank of England goes ahead and sells short-term bills and government securities. This would reduce the bank’s liquid assets as well as raise the interest rates. For instance, if the government trades or sells gilts in large amounts, this would indicate funds transfer from the banking sector to the Bank of England. Therefore, the move would limit the bank’s ability to create credit, thus limiting the growth within the supply of money.
Quantitative easing can be referred to as certain expansion of the monetary base as well as central bank's balance sheet. Rising bond demand and other types of assets should increase their price as well lead to decrease in the long-term interest rates on those assets (OECD, 2013). Therefore, if those long-term interest rates decrease (as the banks get strong and increased balance sheet due to BoE purchases through QE), it would activate lending and strong business growth as well as consumer demands within the economy. This would facilitate the demand of the investors and balance the loan demand (Arestis & Sawyer, 2006). Practically, the Bank of England purchase bonds from UK government – and thus since the government has a high budget deficit, the bonds have been plenty to buy. Thus, it could reach out to the people’s demand.
The purchase of the assets has increased the bank liquidity as well as the pension funds, although some commentators say that the local banks enjoy having the cash as well as hoard it instead of using it as the foundation for lending to consumers and businesses. The availability of credit would, therefore, remain low after the credit crunch since there appears to be signs that the building societies and banks tighten the conditions through which they are ready to offer new loans, mortgages as well as overdrafts (Kates, 2010).
Through this means, the investors seem to have realized the extent of borrowing and decided repay debt through extra saving; although they might not respond to a huge availability of the existing credit due to quantitative easing. On the hand, the banks still engage themselves in a de-leveraging process, which implies that they are usually desperate to decrease the debt they before lending out once more. Again, the banks are careful towards future lending due to significant losses that emerged from the money crisis. The introduction of quantitative policy changed the monetary policy in United Kingdom to price and policy, which appears to be one of the important changes in United Kingdom (King & Plosser, 1984).
It is the responsibility of the Bank of England to ensure that inflation is always on target. They do this through interest rates thus keeping inflation rate at 1% band as compared to the 2% set by the government. In addition, the monetary policy in London is usually designed as pro-active as well as forward-looking since interest rate changes might take prolonged time to work it out.
There are certain factors that the Bank of England should consider while making decisions pertaining balancing the financial system in the country. These include the GDP growth as well as spare capacity: these two refers to the rate of growth of Growth Domestic Policy as well as the size of the output gap (Fama, 1980). The crucial task would be setting monetary policy for the improvement of productive potential. Consumer credit figures and bank lending are other factors to consider and they include withdrawal of equity from the housing market as well as data on lending through credit card.
The bank should also consider equity markets and house prices since they determine the household wealth. It then feeds through towards borrowing as well as retail spending. Monetary policy committee lacks annual rate targets for house price inflation although it does not prevent housing bubbles (Cecchetti & Schoenhholtz, 2011). Also, consumer confidence as well as business surveys could offer “warning in advance” of an economic cycle turning points. The bank also needs to have labor market data to monitor the growth of average earnings, wages and labor costs. The inflation on wage might be due to cost-push inflation.
The banks also detect trends within global markets for foreign exchange. The weaker rate of exchange can be a threat to inflation since it increases the prices of imported services and goods. To detect the common mistakes, there are forward indices like Purchasing Managers’ Index or business confidence surveys as well as the Confederation of British Industry that give certain information on where there exists economic cycle type of economy.
On the other hand, there are ultra-low interest rates that accommodate the monetary policy. Accommodatory monetary policy is deliberately and designed to boost output, as well as AD. The cutting of nominal interest rates to zero or close to that provides a huge monetary stimulus to the economy. This is due to the fact that mortgage payers lack interest to pay, thus increasing the effective disposable for cheaper loans that would offer a possible house prices floor within the property market. Investment that would be under low pressure to achieving interest payments on the loans is also part of the ultra low interest rate. The credit cost should reduce, thus encouraging buying of goods likes a new car or land. Additionally, the decreased interest rates can lead to loss of value of the sterling pound, thus boosting the competition of exports; decreased or low rates are made to encourage business confidence and consumer.
However, some economists, on the prevalent situation, argue that, the usual mechanism for transmission of monetary policy might be spoiled and lead to cutting of interest rates. This is suggested to have little effect on production, prices and demand. This is suggested due to the fact that some banks do not want to lend since majority of the banks are de-leveraging, which means cutting the size of loan books. Also, the incentive meant to loan while interest rates are low in the level are decreased or reduced. There is also low consumer confidence and investors are usually not prepared in commitment to crucial purchases, which could be due to the fact that a recession has made people risk averse as unemployment rises.
In conclusion, the bank of England is responsible for controlling the financial system in United Kingdom through several means. Because of the high or low loan demand, a situation brought about by inflation, the bank uses monetary policy to cover for the high demand or low demand. However, the bank does not result to printing money, as the press refers to such act. The bank came up with a policy called quantitative easing in 2009 to cater for the issues of money demand by the people. The policy relied on expanding balance sheet of central bank as well as monetary situation in the country. This was aimed at accommodating the high demand for loans by the investors and other business people. The policy proved to be a success as it gave positive results in controlling the financial system in United Kingdom.
Arestis, P., & Sawyer, M. C. (2006). A Handbook of Alternative Monetary Economics. Camberley: Edward Elgar Publishing.
Dow, C., & Dow, J. (2013). nside the Bank of England: Memoirs of Christopher Dow, Chief Economist 1973-84. London: Palgrave Macmillan.
Kates, S. (2010). Macroeconomic Theory and Its Failings. Camberley: Edward Elgar Publishing.
Lavington, F. (2013). The English Capital Market. London: Routledge.
OECD. (2013). OECD Economic Surveys: United Kingdom 2013. Paris: OECD Publishing.
Fama, E. (1980) Banking in the Theory of Finance. Journal of Monetary Economics 6, pp. 39- 57.
King, R. and C. Plosser (1984). Money, Credit, and Prices in a Real Business Cycle. American Economic Review 74. Pp.363-380.
Cecchetti, S. and Schoenhholtz. K. (2011). Money, Banking and Financial Markets (3rd ed). McGraw-Hill: Irwin.