Monetary Policy Flashcards
Wide aim on monetarily policy
Financial stability and inflation kept at 2%
Narrow aim of monetary policy
Keep inflation at 2%
Two core purposes of B of E
Monetary stability and financial stability
Costs of inflation
Menu costs
Shoe leather costs
Uncertainty and confusion
Redistribution of income from poor to rich
Redistribution of income from lenders to borrowers
Increase interest rates
Fiscal drag - tax brackets don’t keep up with cpi
Monetary stability aim
Keep stable prices (2% inflation) and confidence in currency
Financial stability aim
Supervise financial markets
Reduce financial risk in system
Act as a lender
What does b of e look after
Financial system as a whole
What does FSA look after
Individual banks and financial organisations
why was FSA disbanded and what did it get split into
failed to adapt to GFC
split into PRA , FPC = organisations of B of E
and also independent organisation known as FCA
What did
financial position executive board do
Give guidance on financial stability
Northern rock collapse
Bank struggling - so b of e lent money to bank in form of emergency loan but made this information public which was the law - but this caused people get frightened and take money out which lead to bank becoming bankrupt
What is FPC
B of e main institution for financial stability q
Aim of FPC
Decrease financial system risk and increase resilience of uk financial system
Who’s in FPC
Internal and external members who provide expertise in niche areas or the market
Why do FPC and MPC have some cross membership
To increase consistency between financial regs and momentary policy
FPC instruments
Countecyclical buffer rate
Sectoral capital requirements
Leveraage ratio requirement
Loan to value, debt to income and interest to cover limits
What is countercyclical buffer rate
International 8 %
Uk 1% but moving to 2%
Capital required by each bank in case of negative economy shock
Sectoral capital requirements
When lending to riskier sectors , banks are required to hold additional capital against i t
Leverage ratio requirements
Limits exposure relative to their capital base
Loan to value , debt to income and interest to cover limits
Limits on mortgages in order to contain risks from housing markets
Stress testing
B of e annual stress test
Able to assess banks resilience and make sure they have enough capital to withstand shocks
Ring fencing
Segregates retail banking from investment activities
PRA 3 aims
Promote safety of firms
Facilitate effective competition
Secure protection for policy holders
What is PRA apart of
B of e
PRC members
Internal and external members q where external members are majority
FCA part of b of e
No
What two questions do fca ask
Are customers getting a fair price
Are financial institutions abusing market power
Principles of monetary policy
Price s stability at 2%
Openness
accountability
credibility
Flexibility
What is bad for economy in regards to inflation
If inflation too high or too low
What happens when inflation not between 1 and 3 percent
Governor must explain to chancelllor why its not in target range and what they plan to do in order to get inflation back at 2 percent
What is cost of bring down inflation in short run
Increase bank rate = increase cost of borrowing so less borrowing and less investment = recession
What does MPC make decisions on
Interest rates and quantitative easing
Why is corridnation between fpc and MPC difficult
Increase bank rates causes a decline in financial stability
Who in MPC
Internal and external members plus non voting member from treasury to inform on latest fiscal updates
Bank rate ta the moment and why
4.5% in order to get inflation down to 4 % by the end of 2023
What is momentary policy report
Reports on financial state of uk and provides forecasts for growth and inflation in the uk
Increases openness of Bank of England
When was b of e made operationally independent
1997
Pros to operational independence
MPC has more expertise than gov
B of e more protected against pressure from gov
Stops potentially buying votes by gov
Limitation B of e operational independence
In extreme events gov can instruct b of e on policy
Price stability defined by gov at 2 percent
MPC required to support gov policy
What are the 3 conventional instruments b of e uses to implement MPC decisions
Operational standing lending / deposit facility
Short term repo
Long term repo
What are the 4 unconventional instruments b of e uses to implement MPC decisions
Discount window facility
Contingent claim repo
QE
Forward guidance
Operational standing lending/deposit facility
Available over night and on demand
Normally lending rate 25 points higher than bank rate
Deposit rate 25 points lower than bank rate
Helps get market rates closer to bank rates and helps banks manage unexpected payments problems
Short term repo
Banks can lend highly liquid assets out for 1 week periods against level A collateral
Helps keep short term interest rates at bank rates by ensuring banks don’t need to pay above bank rate for money reserves
Positive of short term bank repo
Injects central bank money into the economy for short amount of time
Long term repo
Allow banks to borrow central bank money for 6 month periods against broad range of collateral
How are long term repo bids submitted
Banks submit big in terms of spread to bank rate
Higher the spread - more likely to get bid accepted
Discount window facility
On demand facility aimed at banks experiencing liquidity shocks
Borrow form b of e highly liquid assets for less liquid collateral - high interest payments to incentives quick repayment
When use Contingent term repo facility
B of e can activate when there’s market wide stress
What is contingent term repo facility
Allow b of e to increase liquidity of banks for full range of collateral - very flexible
What does b of e lend against
Collateral
Why collateral
Bc if party fails to repay then they can sell collateral to make good of any loss
How does b of e protect itself from falling price of collateral
Lend less than the collateral is worth
Levels of collateral
A high quality highly liquid
B
C less liquid less quality
When did QE start
2009
Why QE
Increase money supply into economy to bring down interest rates and encourage people to spend
How does QE work
B of e creates new money and buys gilts from private corperations
Interest rate on money low so they invest new money into other financial assets which increases demand on finaancial assets so supply increases thus so interest rates decrease which increasing borrowing and investment so spending increase
What does b of e do with interest retuned from gilts
Gives it to the gov
Pros of QE
Increase money supply
Increases demand and production
Asset purschase targets prevents gov from inflating debt away and QE being abused
Ensures monetary policy effective and decrease disruption to financial market s
Cons of QE
Initial effect caused increase in gdp but later rounds have had no effect
Form of government finance which can severely worsen inflation and loses credibility for b of e
Creates unsustainable bubbles in bonds and stock markets
Decrease interest rates for private investors of bonds
Increases inflation which also loses credibility of b of e
Forward guidance started in
2013
Why was forward guidance used
To show increase in bank rate snot imminent
Why did forward guidance back fire
Because initially it was too specific and forecasting variables in the future is very difficult and thus their predictions were wrong
What did this back fire for forward guidance result in
Decrease in forward guidance and made it very vague
Thus b of e further lost credibility
What explains largest variation in imbalances and financial markets
Monetary shocks
What affects probability of boom or bust
Short term interest rates or mortgage market deregulation
What are high cost boom related too
Looser monetary policy
What is problem with inflation and boom
Interest rates to narrowly focused on inflation can cause booms
Why is tailoring monetary policy good for certain areas
Irish interest rate would have been 6.5% higher and this would have reduced House prices by 25-30% before housing bust
What has driven recent high inflation
Volatile energy prices and supply chain issues from covid
Very expansive monetary and fiscal policies to prevent economy collapsing
And increase in central bank money due to QE
What has caused household financial struggles
Increased mortgages and cost of living
How many owner occupied homes will receive an increase rate
4 million
What does fpc judge about banks and why is this contradictory
Banks are resilient and are able to lend if things worsen
However banks are tightening lending as risk has increased which is slowing growth
Why inflation high after war
Monetary financing for war
What was introduced in 80s to decrease inflation
Monetary targeting
Succes of monetary targeting
Unknown as other countries with other strategies achieved lower interest rates
PROBLEMS WITH CORPERATE LOANS
70 percent of corporate loans are floating interest rate which is increasing the cost of borrowing
What is inflation doing to saving
Increased saving ratio
