Monetary Policy Flashcards
What is the countercyclical capital buffer rate?
When cyclical systemic risk is judged to be increasing, institutions should accumulate capital to create buffers that strengthen the resilience of the banking sector during periods of stress when losses materialise
Who sets the countercyclical capital buffer rate?
The FPC
This July, what is the countercyclical buffer rate said to be increasing to?
1% to 2%
What do sectoral capital requirements (SCRs) enable the FPC to do?
Temporarily increase capital requirements on exposures to specific areas
Give an example of an SCR.
If the FPC judged that exuberant commercial property lending posed risks, it could increase SCRs on commercial property loans, so that banks were required to have more capital agaisnt such exposures
What is a leverage ratio requirement?
Limits exposure relative to capital base, helping them to absorb losses and remain solvent
Who can the FPC set a leverage ratio requirements on?
Banks, building societies, and PRA regulated investment firms
What is the UK’s central bank?
The Bank of England
What are the core purposes of the BoE?
Monetary stability and financial stability
What does monetary stability mean?
Stable prices and confidence in the currency
What is monetary policy intended to provide a framework for?
Non-inflationary economic growth
What part of the BoE seek to keep the inflation rate at the recommended rate?
The Monetary Policy Committee (MPC)
How does the BoE play a vital role in maintaining financial stability? (7)
- Reinforcing trust and confidence in money itself
- Supervising financial market infrastructure
- Removing or reducing risks to the financial system as a whole
- Acting as lender and market maker of last resort at times of financial stress
- Promoting the safety and soundness of individual financial institutions
- Safely resolving failing financial institutions
- Collaborating with other financial authorities.
Between 1997 to March 2013, who was responsible for the stability of the financial system as a whole?
The BoE
Between 1997 to March 2013, who supervised individual banks and financial organisations?
The Financial Services Authority (FSA)
What was the high level Standing Committee between 1997-March 2013, and who was it composed of?
Representatives from the BoE, the FSA and HM Treasury was supposed to develop a common position on any problems
What part of the BoE contributed to the Standing Committee?
Financial Stability Executive Board
Why was a new regulatory framework created in April 2013?
Due to the framework failing to identify problems that led to the Financial Crisis of 2007-09
What is the BoE main policy institution in the area of financial stability?
The Financial Policy Committee (FPC)
What is the primary objective of the FPC?
Identifying, monitoring and taking action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system
What is the FPCs second objective?
Support the economic policy of the government
How many members are there in the FPC?
13
Who are the members of the FPC?
- Governor
- 4 x deputy Governors
- Executive Director for Financial Stability Strategy and Risk
- CEO of FCA
- 5 x external members
- Member from HM Treasury
Where do the 4 x Deputy governors of the FPC come from?
Financial Stability,
Markets & Banking,
Monetary Policy
Prudential Regulation (i.e., the CEO of the Prudential Regulation Authority, PRA).
What is special about the HM Treasury member of the FPC?
They are a non-voting meber
What is cross-membership of the FPC and the MPC designed to promote?
Consistency between financial regulation and monetary policy
What are the 5 FPC instruments?
Countercyclical capital buffer rate
Sectoral capital requirements
Leverage ratio requirement
Loan-to-value and debt-to-income limits for UK mortgages on owner-occupied properties
Loan-to-value and interest-cover-ratio limits for UK mortgages on buy-to-let properties
What are loan-to-value, debt-to-income, and interest-cover-ratio limits require?
Require regulated lenders to place limits on residential mortgage lending
What is the interest coverage ratio?
The ratio of expected rental income from a buy-to-let property to the estimated mortgage interest payments over a given time period
What does stress testing allow for and who contributes to the framework?
Stress tests allow the FPC and the PRC to assess banks’ resilience and make sure they have enough capital to withstand shocks, and to support the economy if a stress does materialise
FPC and the Prudential Regulation Committee (PRC)
What is ring fencing?
Separates banks’ retail banking activities from their wholesale and investment banking activities
What is the PRA responsible for?
Prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms
What are three objectives of the PRA?
(i) to promote the safety and soundness of these firms; (ii) for insurers, to contribute to the securing of an appropriate degree of protection for policyholders; (iii) to facilitate effective competition.
What institutions does the PRA focus on?
Institutions and issues which pose the greatest risk to the stability of the financial system.
What is the PRA apart of?
The BoE
What policy is the PRC responsible for?
PRA policy
What generally in terms of firms is the PRC responsible for?
The most significant supervisory decisions about individual financial firms
Who are the members of the PRC?
Governor (chair)
Deputy Governors for Financial Stability, Markets and Banking, and Prudential Regulation
Chief Executive of the Financial
Conduct Authority (FCA)
Six other external members, selected for their experience and expertise in financial services
Is the Financial Conduct Authority (FCA) apart of the BoE?
No, it is a separate institution
What is the FCA responsible for?
For promoting effective competition, ensuring that relevant markets function well, and for the conduct regulation of all financial services firms
Who does the FCA operate the prudential regulation of?
Those financial services firms not supervised by the PRA, such as asset managers and independent financial advisers
Monetary policy is conducted according to 5 key principles, outline them.
Clear and precise objectives
Flexibility
Openness and transparency
Accountability
Credibility
What is the primary objective of monetary policy?
Price stability
What is the UK’s inflation target?
2% +/- 1%
What is meant by the monetary policy needing to show openness and transparency?
Publications of MPC members’ voting records, publication of the minutes of MPC meetings and publication of the BoE’s quarterly “Monetary Policy Report
Who are the BoE accountable for?
Government, parliament and the wider public
What is the inflation target expressed in terms of?
The CPI
What happens if inflation is 1% above or below the target?
The Governor must explain in an open letter to the Chancellor the reasons for the deviation and what the BoE intends to do to ensure inflation comes back to target.
What study suggests 2% is not the optimal inflation rate?
Bakhshi et al. (1999) study
How does the BoE seek to meet the inflation target?
Setting short-term interest rates
Quantitative easing
Who makes the two main policy decisions in the BoE?
The MPC
When was the MPC established?
1997
How many members are there in the MPC?
9
Who are the 9 members of the MPC?
Governor
3 x Deputy Governors
- Monetary Policy
- Financial Stability
- Markets and Banking
- Bank’s Chief Economist
- 4 x external members
Who appoints the external members of the MPC?
The chancellor
Who also sits in on the MPC meetings?
A representative from the Treasury
What is the purpose of the Treasury member sitting in on MPC meetings?
To ensure that the MPC is fully briefed on fiscal policy developments and other aspects of the government’s economic policies and that the Chancellor is kept fully informed about monetary policy
What is the average time-lag of monetary policy?
2 years
When did the BoE become operationally independent?
1997
How is the BoE independence to conduct monetary policy limited?
In extreme circumstances, the national interest demands that the government has the power to give instructions to the BoE
Who appoints MPC Governors and Deputy Governors of the BoE?
The crown, selected by government
Can members of the MPC be reappointed?
Yes
What are the pros of the BoE having operational independence? (2)
The MPC has more expertise than the government.
To some degree, the BoE is protected from potential pressure by the government to pursue a lax monetary policy
What are the cons of the BoE operational independence?
The BoE’s independence is substantially limited in various ways
How many times does the MPC meet a year?
8 meeting rounds consisting of 3 meetings per round
When is the inflation target announced?
At the annual budget statement
Subject to the primary target of hitting the inflation target, what is the MPC required to support?
The government’s economic policy, notably its objectives for growth and employment
Is the BoE allowed to buy government debt?
Yes
What are monetary aggregates?
Broad measures of how much money exists in an economy at various levels, including currency, deposits, and credit.
What is the M0 money aggregate?
This is the narrow measure of money and consists of:
- Notes and coins outside the BoE
- Bankers’ operational deposits with the BoE
What is the M4 monetary aggregate?
This is a broad measure of money and consists of:
- Notes and coins held by the M4 private sector
- All M4 private sector retail and wholesale sterling deposits at MFIs in the UK
What is M4 closely related to? (2)
Aggregate demand and inflation
What is the downside of M4 and why?
BoE can’t control it very easily. Commercial banks can influence it heavily through issuing loans.
Who controls M0?
The BoE
What is larger, M0 or M4?
M4
What are the three conventional instruments of monetary policy?
Operational Standing Facility
Short-Term Repo Operations
Long-Term Repo Operations
What are the 4 unconventional instruments of monetary policy?
Discount Window Facility
Contingent Term Repo Facility
Quantitative Easing
Forward Guidance
What are operational standing facilities?
Operational standing deposit and lending facilities that are available overnight only and may be used on demand to banks.
What are the normal lending/deposit rates at?
25 basis points higher/lower then the bank rate
What is the main purposes of the operational standing facility? (2)
To help stabilise market rates close to bank rates.
Help banks manage unexpected payment problems.
What is a repo?
Repurchase agreement- selling an asset to another party and agreeing to buy the asset or a similar asset back at a specified time in the future
What is the main advantage of a repo operation for the BoE?
Injects central bank money into the banking system for a limited period
What do short-term repos allow for?
Allow banks to borrow central bank reserves from the BoE for a one week period in exchange for high quality, highly liquid assets.
How long are short-term repos?
One week
How are short term repos carried out?
via auctions on a weekly basis
What are short-term repos paid at?
Bank rate
What is the supply of short term repos from the central bank said to be?
Unlimited supply
What is the period for long-term repo operations?
Six month period
How often does the BoE conduct long-term repos?
Either weekly or monthly
How do banks apply for long term repo operations?
Banks submit bids in terms of spreads to the Bank Rate. The higher the spread they bid, the more likely it is that the BoE will allocate them these funds
What is discount window facility?
It allows banks to borrow form the BoE highly liquid assets (usually gilts) against liquid collateral in potentially large size and for a variable term
Who is the discount window facility aimed at?
Banks experiencing a firm-specific or market-wide liquidity shock
What incentivises banks to repay borrowing through the discount window facility?
The fee charged is set at a premium to the market
What is the contingent term repo facility?
BoE can activate in response to actual or prospective market-wide stress of an exceptional nature
What does the contingent term repo facility enable the BoE to do?
Provide additional liquidity to banks against the full range of eligible collateral
What is collateral?
If a counterparty fails to repay when due, the BoE can sell or retain the collateral to make good any loss it may face
What are the 3 sets of collateral?
Level A: Highly liquid and quality sovereign securities
Level B: Liquid, high quality sovereign, supranational, mortgage and corporate bond
Level C: Less liquid securities and portfolios of loans
When the BoE lends to its operations, it does so against…
…Collateral
In short term monetary policy oeprations, what type of collateral is used?
What about longer term?
Level A
All levels
How does the BoE protect itself against falls in the value of collateral?
They lend less than the market value of the collateral (haircut)
Lower level collateral is subject to larger haircuts
What happened in March 2009 in terms of QE?
The MPC decided to undertake a series of asset purchases, in order to give a monetary stimulus to the economy
What is the main purpose of QE?
To reduce borrowing costs and boost spending
How does QE work?
- BoE electronically creates new money and uses it to purchases gilts from private investors such as pension funds and insurance companies
- Normally , these investors do not want to hold onto this money, because it yields low returns
- These investors now purchase other assets, such as corporate bonds and shares
- This lowers the return on these types of bonds and shares
- This lowers longer-term borrowing costs and encourages the issuance of new equities and bonds that should stimulate spending
What happens to all the interest earned on the gilts from QE by the BoE?
All interest earned by the BoE is given to the government
What are shoe-leather costs?
The costs that people incur to minimise their cash holdings during times of high inflation
What is fiscal drag?
The deflationary effect of a progressive taxation system on a country’s economy. As wages rise, a higher proportion of income is paid in tax
When was forward guidance introduced?
August 2013
What is forward guidance?
Refers to the communication from a central bank about the state of the economy and likely future course of monetary policy.
