LaToya asked in Social ScienceEconomics · 1 decade ago

According to Birchwood...?

According to Birchwood, why is monetary policy easier to implement when banks are mainly domestically owned as oppsed to foreign owned?

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  • 1 decade ago
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    Best is to hear from the horses mouth: contact Anthony Birchwood, Research Fellow, Caribbean Centre for Monetary Studies,The University of the West Indies

    St. Augustine Campus, Trinidad and Tobago.

    About the Bank of England, its says what its policies are:

    The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment. Price stability is defined by the Government’s inflation target of 2%. The remit recognises the role of price stability in achieving economic stability more generally, and in providing the right conditions for sustainable growth in output and employment. The Government's inflation target is announced each year by the Chancellor of the Exchequer in the annual Budget statement.

    The 1998 Bank of England Act made the Bank independent to set interest rates. The Bank is accountable to parliament and the wider public. The legislation provides that if, in extreme circumstances, the national interest demands it, the Government has the power to give instructions to the Bank on interest rates for a limited period.

    The inflation target

    The inflation target of 2% is expressed in terms of an annual rate of inflation based on the Consumer Prices Index (CPI). The remit is not to achieve the lowest possible inflation rate. Inflation below the target of 2% is judged to be just as bad as inflation above the target. The inflation target is therefore symmetrical.

    If the target is missed by more than 1 percentage point on either side – i.e. if the annual rate of CPI inflation is more than 3% or less than 1% – the Governor of the Bank must write an open letter to the Chancellor explaining the reasons why inflation has increased or fallen to such an extent and what the Bank proposes to do to ensure inflation comes back to the target.

    A target of 2% does not mean that inflation will be held at this rate constantly. That would be neither possible nor desirable. Interest rates would be changing all the time, and by large amounts, causing unnecessary uncertainty and volatility in the economy. Even then it would not be possible to keep inflation at 2% in each and every month. Instead, the MPC’s aim is to set interest rates so that inflation can be brought back to target within a reasonable time period without creating undue instability in the economy.

    The Monetary Policy Committee

    The Bank seeks to meet the inflation target by setting an interest rate. The level of interest rates is decided by a special committee – the Monetary Policy Committee. The MPC consists of nine members – five from the Bank of England and four external members appointed by the Chancellor. It is chaired by the Governor of the Bank of England. The MPC meets monthly for a two-day meeting, usually on the Wednesday and Thursday after the first Monday of each month. Decisions are made by a vote of the Committee on a one-person one-vote basis.

    Communications

    The interest rate decision is announced at 12 noon on the second day. The minutes of the meetings, including a record of the vote, are published on the Wednesday of the second week after the meeting takes place. Each quarter, the Bank publishes its Inflation Report, which provides a detailed analysis of economic conditions and the prospects for economic growth and inflation agreed by the MPC. The Bank also publishes other material to increase awareness and understanding of its monetary policy function.Interest rates are set by the Bank’s Monetary Policy Committee. The MPC sets an interest rate it judges will enable the inflation target to be met. The Bank's Monetary Policy Committee (MPC) is made up of nine members – the Governor, the two Deputy Governors, the Bank's Chief Economist, the Executive Director for Markets and four external members appointed directly by the Chancellor. The appointment of external members is designed to ensure that the MPC benefits from thinking and expertise in addition to that gained inside the Bank of England.

    When the Bank of England changes the official interest rate it is attempting to influence the overall level of expenditure in the economy. When the amount of money spent grows more quickly than the volume of output produced, inflation is the result. In this way, changes in interest rates are used to control inflation.

    The Bank of England sets an interest rate at which it lends to financial institutions. This interest rate then affects the whole range of interest rates set by commercial banks, building societies and other institutions for their own savers and borrowers. It also tends to affect the price of financial assets, such as bonds and shares, and the exchange rate, which affect consumer and business demand in a variety of ways. Lowering or raising interest rates affects spending in the economy.

    A reduction in interest rates makes saving less attractive and borrowing more attractive, which stimulates spending. Lower interest rates can affect consumers’ and firms’ cash-flow – a fall in interest rates reduces the income from savings and the interest payments due on loans. Borrowers tend to spend more of any extra money they have than lenders, so the net effect of lower interest rates through this cash-flow channel is to encourage higher spending in aggregate. The opposite occurs when interest rates are increased.

    Lower interest rates can boost the prices of assets such as shares and houses. Higher house prices enable existing home owners to extend their mortgages in order to finance higher consumption. Higher share prices raise households’ wealth and can increase their willingness to spend.

    Changes in interest rates can also affect the exchange rate. An unexpected rise in the rate of interest in the UK relative to overseas would give investors a higher return on UK assets relative to their foreign-currency equivalents, tending to make sterling assets more attractive. That should raise the value of sterling, reduce the price of imports, and reduce demand for UK goods and services abroad. However, the impact of interest rates on the exchange rate is, unfortunately, seldom that predictable.

    Changes in spending feed through into output and, in turn, into employment. That can affect wage costs by changing the relative balance of demand and supply for workers. But it also influences wage bargainers’ expectations of inflation – an important consideration for the eventual settlement. The impact on output and wages feeds through to producers’ costs and prices, and eventually consumer prices.

    Some of these influences can work more quickly than others. And the overall effect of monetary policy will be more rapid if it is credible. But, in general, there are time lags before changes in interest rates affect spending and saving decisions, and longer still before they affect consumer prices.

    We cannot be precise about the size or timing of all these channels. But the maximum effect on output is estimated to take up to about one year. And the maximum impact of a change in interest rates on consumer price inflation takes up to about two years. So interest rates have to be set based on judgments about what inflation might be – the outlook over the coming few years – not what it is today.

    Setting interest rates

    As banker to the Government and the banks, the Bank is able to forecast fairly accurately the pattern of money flows between the Government's accounts on one hand and the commercial banks on the other, and acts on a daily basis to smooth out the imbalances which arise. When more money flows from the banks to the Government than vice versa, the banks' holdings of liquid assets are run down and the money market finds itself short of funds. When more money flows the other way, the market can be in cash surplus. In practice the pattern of Government and Bank operations usually results in a shortage of cash in the market each day.

    The Bank supplies the cash which the banking system as a whole needs to achieve balance by the end of each settlement day. Because the Bank is the final provider of cash to the system it can choose the interest rate at which it will provide these funds each day. The interest rate at which the Bank supplies these funds is quickly passed throughout the financial system, influencing interest rates for the whole economy. When the Bank changes its dealing rate, the commercial banks change their own base rates from which deposit and lending rates are calculated. The table below links to the News Release for each MPC decision.

    Date News Release Minutes

    8 Nov Bank of England Maintains Bank Rate at 5.75% 21 Nov

    (134k)

    4 Oct Bank of England Maintains Bank Rate at 5.75% 17 Oct

    (94k)

    6 Sep Bank of England Maintains Bank Rate at 5.75% 19 Sep

    (116k)

    2 Aug Bank of England Maintains Bank Rate at 5.75% 15 Aug (94k)

    5 Jul Bank of England Raises Bank Rate by 0.25 Percentage Points to 5.75% 18 July (95k)

    7 Jun Bank of England Maintains Bank Rate at 5.5% 20 June(95k)

    10 May Bank of England Raises Bank Rate by 0.25 Percentage Points to 5.5% 23 May (114k)

    5 Apr Bank of England Maintains Bank Rate at 5.25%

    *Remit letter available under Related Links

    18 Apr

    (95k)

    8 Mar Bank of England Maintains Bank Rate at 5.25% 21 Mar(102k)

    8 Feb Bank of England Maintains Bank Rate at 5.25% 21 Feb(102k)

    11 Jan Bank of England Raises Bank Rate

    by 0.25 Percentage Points to 5.25%

    24 Jan (106k)

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