Central Bank Review and Efficacy of Monetary Policy
Introduction
The central bank of the UK, commonly referred to as the Bank of England, is an integral arm in the UK economy mandated to regulate money and offer financial services alongside ensuring economic stability in the country. It is a model from which other central banks around the world have been formed (Bank of England, 2020). Since its inception, the bank has played as a private money lender to the British government until it became the official central bank of the country (Capie, 2018). Its roles revolve around bank regulation, provision of financial services like economic research, and monetary policy (Bank of England, 2020). All these efforts are geared towards stabilizing the national currency, thereby maintaining low unemployment terms and preventing inflation.
Roles of the Bank of England
The primary function of the Bank of England (BoE) is to maintain monetary stability as well as the financial stability of the British economy. Monetary stability reflects on the ability to maintain stable prices and the confidence of the UK currency (Bank of England, 2020). Arestis and Sawyer (2013) indicate that stability of prices comes in handy with issuing of banknotes, a role that the bank has overseen over the last decades successfully. On the other hand, currency confidence pertains to ensuring the circulation of the UK sterling pound is genuine in the country’s close economy (Arestis and Sawyer, 2013). The Bank of England is also mandated with the Monetary Policy Committee (MPC) formation, which is an integral arm led by the Governor of the Bank of England that formulates the monetary transmission model (Warsh, 2014). Capie (2018) explains that the committee’s purpose is to ensure a regular alteration of the interest rate policy, which helps accomplish the government’s inflation target. Further, the Monetary Policy Committee is entitled to the duty to monitor the county’s economic development.
On the other hand, Goodhart et al. (2013) observe that financial stability encompasses the monitoring and overseeing of the British economic systems across the country’s vast financial institutions and markets. The BoE carries out market surveillance and conducts market intelligence functions which aid in detecting threats faulted upon such institutions (Goodhart et al., 2013). In this light, it fulfills the responsibility of safeguarding financial institutions against any kind of threats such as bribery, counterfeiting, and money laundering, which are apparent challenges that most banks encounter. The bank thrives through these functions with the aid of the Financial Policy Committee (FPC) and the Prudent Regulation Authority (PRA), which were established under the British Financial Services Act of 2012 (Bank of England, 2020). The FPC performs the duty of identifying, monitoring, and taking necessary measures against perils, which tend to compromise the British financial system (Bank of England, 2020). At the same time, the PRA is in charge of regulating commercial banks, credit unions, insurers, and the UK’s investment firms.
Additionally, the bank also acts as the official custodian of the Gold reserves. The Bank of England is the second largest vault system for protecting world gold capacities after the United States New York Federal Reserve (Warsh, 2014). The custodianship is an embedded role for both the UK and other trustee countries (Bank of England, 2020). For instance, estimates measure out that at least 3% of the world gold is held in the BoE. The bank acts as the lender of the last resort to the commercial banks that face the cash fall crisis, which helps in liquidity regulation in the UK economy.
Monetary Tools
Monetary tools are mechanisms applied by the Bank of England to control the flow of money in the economy through which it is easily able to assess the rate of inflation. The monetary tools are classified as either conventional or non-conventional, with which the bank exercises its authority (Bank of England, 2020). The Monetary Policy Committee determines conventional tools such as interest rates as per the government’s inflation target (Tenreyro, 2019). For instance, before the BoE sets a base rate, it considers aspects like consumer confidence, unemployment levels, and the exchange rate index (Bank of England, 2020). Through these constructs, the BoE decides the impact of inflation, whether it will rise or fall; hence, interest rate decisions are based on this impact. For example, if a higher rate of inflation is often expected above the government’s target of 2%, increased interest rates will be set. In contrast, if low inflation is anticipated, a cut of interest rate will prevail (Tenreyro, 2019).
Further, the money supply reflects on the flow of cash and overall costs in the economy. Through interest rates, the bank regulates the amount of money supply in the market. More particularly, if the BoE issues an increase in base interest, which causes an adjacent rise of interest rates, then the money supply is reduced. This is because increased interest rates lead to inflated borrowing; thus, both the public and the commercial banks experience difficulty maintaining cash liquidity (Tenreyro, 2019). Consequently, low-interest rates result in lenient borrowing costs that tend to increase the money supply in the economy.
Joyce, Miles, Scott, and Vayanos (2012) note that non-conventional policies like quantitative easing also aid the BoE in regulating the money supply. It illuminates attempts made by the bank to create money electronically through government bonds from banks intended to purchase assets (Joyce et al., 2012). This attempt is tailored to reduce the pressures attributed to deflation by increasing the money supply. Likewise, the negative interest rate policy where interest rates are near or below zero is only applied, with extra-ordinary economic ordinances such as financial crisis (Han, 2016). In such a case, the BoE sets its nominal interest target rates with a negative value, a motive aimed at encouraging borrowing, spending, and investments. For instance, Han (2016) states that the method was used after the financial breakdown of 2008, where the BoE had to employ such a lucrative measure to leverage the economy.
Assessment of Monetary Policy
The overarching goal of the monetary policy is to ensure the UK’s stability in a myriad of ways. More particularly, as Bahaj et al. (2019) establish, the system is anticipated to ensure full employment and achieve a high rate of economic growth. Further, (Bank of England, 2020), it must stabilize asset prices in the money markets and other financial institutions. Through the regulation of interest rates, the Bank of England can effectively manage the inflation levels as per the set targets (Bahaj et al., 2019). Also, the bank ensures equitable income distribution by stabilizing prices and wages alongside controlling the amount of public debt (Bank of England, 2020). Debt regulation entails the chance the UK government can borrow from external financial institutions, which inadvertently may lead to inflation if not well monitored. For instance, in cases where there is an extreme flow of money in the economy, the BoE restrains the government from borrowing.
Whether BoE can Control Financing Conditions
Goodhart et al. (2013) note that among the integral roles of the Bank of England is maintaining financial stability. Therefore, it has been affirmed that it can control financial conditions as well as behaviors like consumption and savings (Goodhart et al., 2013). This role is fully integrated with its other duties, such as interest rate and inflation regulation and money supply stability. Through control of money circulation, the BoE impacts public aspects, such as investments, savings, and consumption rates (Bank of England, 2020). An apt example is where the BoE intends to increase money circulation to lower investment costs and increase spending. Han (2016) records that this case was mainly witnessed during the 2007-2008 financial crisis, where the bank introduced the quantitative easing programs to swell up the amounts in the commercial banks, thereby encouraging them to borrow more. Alternatively, if the BoE anticipates an increase in growth and a rise in the inflation rate, it adopts enacts mechanisms such as high-interest rates that discourage people from borrowing money for investments and consumption (Bank of England, 2020). Consequently, money flow is reduced while investments experience a shortfall.
Changes the BoE Intends to Enact on its Monetary Policy
Following the past financial crisis, as Burgess et al. (2013) note, it is evident that the country cannot bear higher rates any other time. Therefore, the bank has identified lucrative measures that may help extenuate the impact of its monetary policy (Bernanke, 2017). First, the bank has decided to break the zero bound on bank rates by altering the exchange rates between cash and deposits (Burgess et al., 2013). Through efforts by both external and internal members of the Monetary Policy Committee, the bank intends to become more accountable in the path of bank rate where there are clear explanations on assumptions and judgments from these members. Further, the BoE will publish more effective policy guidance on the expected paths of bank rates to improve its ability to influence market curves alongside internal restraining inconsistencies.
Conclusion
The UK central bank plays an impetus role in the British economy, which has enabled the country to thrive in economic and financial developments. Among its functions is issuing of currency, lending last resorts, monetary policy, and maintenance of financial stability as well as acting as the custodian of gold reserves. The monetary system has ensured equitable income distribution, high employment levels, increased economic growth, and deterrence of rising inflation levels. This has assured an equal developed Britain that it is set to thrive even in times of future crisis, such as the current economic recession of the COVID-19 crisis.
References
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