Question

The Bank of England (Central Bank)

Part 1: Background knowledge: what is the role and objectives of the central bank in your country? Provide a brief overview of how your country ́s central bank conducts monetary policy. Using a graph created in a package like Excel, show and discuss how the monetary policy instrument has changed over time starting from 1990.

Part 2: What are the current domestic conditions you think are relevant for deciding what to do with the monetary policy instrument?

Part 3: What are the current external (foreign) conditions you think are relevant for deciding what to do to with the monetary policy instrument?

Part 4: What is the likely impact of these conditions on the AD curve? * Note: to decide this, you need to take all relevant factors in parts 2 and 3 into account and draw only one shift or no change.

Part 5: What is the likely impact of these conditions on the AS curve? * Note: to decide this, you need to take all relevant factors in parts 2 and 3 into account and draw only one shift or no change.

Part 6: Based on the above, what do you think your country ́s central bank should do and why? * Note: here, you should also explain any assumptions that you made to reach your recommendation and any limitations of your recommendation (hint: see notes for parts 4 and 5).

Answer 1

Answer :

The Bank of England is responsible for managing UK monetary policy and maintaining the supply of money in the economy. The Bank of England is independent of the government. Although, the government can appoint members and set the inflation target. However, the Bank has a key role to play in the management of the economy and finance sector.

Main functions of a central bank

1. Monetary policy function
   1. Setting of the main monetary policy interest rate
   2. Quantitative easing
   3. Exchange rate intervention (managed/fixed currency systems)
2. Financial stability & regulatory function
   1. Supervision of the wider financial system
   2. Prudential policies designed to maintain financial stability
3. Policy operation functions
   1. Lender of last resort to the banking system
   2. Managing liquidity in the commercial banking system
4. Financial infrastructure provision function
   1. Overseeing the payments systems used by banks / retailers / credit card companies
   2. Debt management
   3. Handling the issue and redemption of issues of government debt

Explanation on some Functions of the Bank of England

• Money Supply. The Bank of England is responsible for issuing bank notes and coins. They need to print enough to meet demand, without causing excess inflation.
• Lender of Last Resort. The bank of England is also the lender of last resort. This means that if commercial banks suffer a shortfall of cash then they can always borrow money from the Bank of England. This is an important function has it helps maintain liquidity and confidence in the banking system. This role was tested in 2007 when Northern Rock couldn’t raise enough funds on the money markets and were forced to borrow from the Bank of England with government acting as guarantor.
• Setting Interest Rates. In particular the Bank have an inflation target of CPI 2% +/-1. The Bank produces an inflation forecast and set interest rates according to predictions of future inflation.

Current objectives of UK monetary policy

Monetary stability means stable prices and confidence in the currency. Stable prices are defined by the Government's inflation target, which the Bank seeks to meet through the decisions taken by the Monetary Policy Committee (MPC).

The Bank of England has been independent of the UK government since May 1997. The current governor is Mark Carney.

An Era of Extraordinary Monetary Policy :

Central Banks of many advanced countries have made extraordinary sustained use of expansionary monetary policy in recent years:

Policy interest rates approaching the zero bound and remaining there (e.g. 0.5% in the UK and in the USA)

Negative policy rates in some countries (e.g. Japan, Sweden, Denmark and Switzerland)

Huge rise in the scale of quantitative easing (QE) designed to increase the base supply of money

Increasing use of exchange rate (currency) intervention as an instrument of monetary policy (i.e. a move towards managed floating)