Demand-Side Policies - Monetary 2

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Monetary Policy - Money Supply

The Bank of England (BoE) also has control over the money supply in the UK economy. Since the 2008 financial crisis, the BoE has undertaken a programme of quantitative easing, injecting new money into the economy to boost it.

Quantitative easing (QE)

The central bank creates new money (adding zeros to their bank account).
They then use this new money to purchase bonds.
By selling the bonds to the central bank, commercial banks or pension funds now have more cash to spend elsewhere in the economy. So the new money is injected into the economy.

Quantitative easing (QE) cont.

The BoE's demand for government bonds increases their price, which brings down their yield (return). This means that the pension funds and banks go in search of a higher yield. For example, housing or the stock market.
But the pension funds or banks may hoard the money or invest it abroad.

Issues with QE

Increasing the money supply could give rise to inflationary pressure because there is now more money chasing the same amount of goods - potentially causing prices to rise.
A criticism has been that it allowed financial institutions to hoard this money rather than invest it into the 'real economy' after 2008, another form of bail out.
But it is seen as a useful tool to stimulate the economy when interest rates are virtually as low as they can go (at a zero rate bound).

Bank of England

The Bank of England (BoE) is the central bank of the UK and was made operationally independent in 1997. This means that it is not directly accountable to the government.

Bank of England's objectives

Since becoming independent, inflation (price stability more formally) has been the BoE's target – in 1997 it was set at 2.5%. In 2004, the government changed the Bank’s target to 2%.
The BoE is allowed a range of +/- 1 percentage point in the inflation outcome before it has to write a letter to the Chancellor explaining why inflation is away from target, what is being done about it and when we can expect it to be back on target.
The UK government has not set a target for the exchange rate since 1992.

Monetary Policy Committee (MPC)

The MPC is the body within the Bank of England that is in charge of achieving price stability.
It is made up of nine members – the Governor, the three Deputy Governors for Monetary Policy, Financial Stability and Markets and Banking, the Chief Economist and four external members appointed directly by the Chancellor.
They normally meet once a month to vote on whether there will be a change to monetary levers or not. The vote is determined by a simple majority with every member having an equal vote.

Factors affecting MPC's decision

Inflation expectations.
Consumer spending forecasts.
Real GDP growth rate.
Exchange rate.
Trade balance
Consumer and firms’ confidence.
State of labour market, full employment, wage pressures – unemployment and employment trends.