bank of england
The Bank of England occupies a pivotal position in the economic life of the nation!
- The Bank is the UK's Central Bank
- It was established in 1694 and nationalized in 1946
- The Bank was given operational independence by Labour Chancellor Gordon Brown in May 1997
- Current Governor is Eddie George (He has announced his intention to retire in 2003)
- The Bank's Monetary Policy Committee meets monthly to determine short term interest rates Government sets the inflation target (RPIX = 2.5%)
MAIN FUNCTIONS OF THE BANK OF ENGLAND
The Bank performs a number of important functions within the financial system.
- Banker to the Government
- Manages the issue of Government Debt
- Banker to the Commercial Banks
- Holds gold and foreign-exchange reserves
- Manages the issue of notes and coins
- Implements domestic monetary policy
- Supervises banks and other financial companies (this function changes in 1999)
THE ROLE OF THE MONETARY POLICY COMMITTEE
The Monetary Policy Committee meets each month to set the official base rate of interest for the economy. They have been given an inflation target by the government of 2.5% (+ or - 1%). their job is to set interest rates at an appropriate level to meet the inflation target over a two year time horizon.
The Monetary Policy Committee meets each month to assess the inflation risk for the UK and make their decision on base interest rates. Their two-day meeting involves a detailed round-table discussion of the latest macroeconomic developments. They factor into their discussions many separate indicators - including the strength of demand and output, consumer spending, trends in the housing market and recent developments in the foreign exchange market. They also look at information coming from the labour market - for example the growth of wages and earnings, indicators of skills shortages and recent changes in unemployment.
If the Bank believes that aggregate demand is rising too quickly and putting upward pressure on prices - it will decide to raise interest rates to curb the growth of spending in the economy
Demand-pull inflation ......
Each meeting includes a thorough assessment of key economic trends together with analysis of how these trends will impact on inflation. A vote is taken at the end of the meeting about whether to change interest rates and if so - in what direction and by how much? The Governor of the Bank has a casting vote if there is a 4-4 split between the other eight members of the committee.
What factors does the MPC consider when making interest rate decisions?
Many economic factors can affect the final interest rate decision. Broadly, the MPC is looking to see how strongly the economy is performing and whether there is a risk of an acceleration in inflation unless policy is tightened through higher interest rates. Equally there may be obvious signs that the economy is in a slowdown phase - in which case a relaxation of policy (lower interest rates) might be considered.
Some of the economic indicators looked at include
Domestic monetary developments
- growth of the money supply (including both narrow and broad measures of money)
- bank & building society lending figures
- high street consumer credit data
- trends in UK share prices
- house prices
Exchange rate statistics
- recent trends in the global foreign exchange markets - including the value of sterling against a range of other currencies
- perceived impact of exchange rate on the real economy - for example - if the strong pound helping to keep inflation under control
Demand and output data
- retail sales data
- total consumers' expenditure
- consumer confidence indicators
- GDP figures (trends in total national output)
- manufacturing output
- service sector production
- capacity utilisation rates (e.g. CBI and BCC quarterly surveys) - one indicator of how much spare capacity there is left in the economy
- international economic backdrop (e.g. economic developments in Asia and North America)
Labour market signals (very important)
- growth of average earnings
- growth of unit labour costs
- unemployment figures
- survey evidence on skills shortages
All of this data is considered very carefully. Is the economy showing signs of over-heating? Or are signs of inflation fairly weak - allowing interest rates to remain where they are or fall?
Monetary Policy is not an exact science! Sometimes mistakes are made and
the macro-economic signals can be misinterpreted. The job of the members of
the Monetary Policy Committee is to read the "economic tea-leaves"
as well as they can using their combined economic judgement and then
make decisions on interest rates for the good of the economy as a whole!
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