2.6.2. Role of the Bank of England (Monetary Policy)

This Edexcel economics study note looks at the Role of the Bank of England (Monetary Policy).

The Bank of England (BoE) is the central bank of the United Kingdom. One of its primary functions is to conduct monetary policy through its Monetary Policy Committee (MPC). The MPC is responsible for setting the interest rate and other monetary policies to achieve the government’s inflation target and support economic growth.

The Role and Operation of the Monetary Policy Committee

Formation and Purpose:

• The MPC was established in 1997 to enhance the transparency and accountability of monetary policy.
• Its main objective is to maintain price stability, primarily by targeting a 2% inflation rate.

Structure:

• The MPC consists of nine members: the Governor of the Bank of England, three Deputy Governors, the Chief Economist, and four external members appointed by the Chancellor of the Exchequer.
• Members are selected for their expertise in economics and monetary policy.

Decision-Making Process:

• The MPC meets eight times a year to review economic conditions and set the Bank Rate.
• Decisions are made by majority vote, and the minutes are published to ensure transparency.

Policy Instruments:

• Bank Rate: The primary tool used to control inflation and influence economic activity.
• Quantitative Easing (QE): Purchasing government and corporate bonds to increase the money supply and lower interest rates.
• Forward Guidance: Communicating future policy intentions to influence economic expectations.

Real-World Examples

• Global Financial Crisis (2008-2009):
  • The MPC reduced the Bank Rate to a historic low of 0.5% to stimulate the economy.
  • Initiated QE, purchasing £200 billion of assets to increase liquidity.
• Brexit (2016):
  • Following the referendum, the MPC cut the Bank Rate to 0.25% to support economic stability.
  • Expanded QE with an additional £60 billion of government bond purchases.

Economic Perspectives

Keynesian Perspective:

• Supports active monetary policy to manage economic demand.
• Advocates for low interest rates and QE during recessions to stimulate growth.

Monetarist Perspective:

• Emphasizes controlling the money supply to manage inflation.
• Prefers a rules-based approach to monetary policy, focusing on price stability.

Austrian Perspective:

• Criticizes central bank interventions for creating economic distortions.
• Advocates for minimal intervention and a return to sound money principles.

Time-line of Key Dates

• 1997: Establishment of the MPC.
• 2008-2009: Global Financial Crisis; Bank Rate cut to 0.5%, QE initiated.
• 2016: Brexit referendum; Bank Rate cut to 0.25%, QE expanded.
• 2020: COVID-19 pandemic; Bank Rate reduced to 0.1%, further QE measures implemented.

Possible Essay-Style Questions

1. Discuss the role of the Monetary Policy Committee in maintaining price stability in the UK economy.
2. Evaluate the effectiveness of quantitative easing as a tool for monetary policy, with reference to the actions of the Bank of England during the Global Financial Crisis.
3. Analyze the impact of Brexit on the monetary policy decisions of the MPC.
4. Compare and contrast the Keynesian and monetarist perspectives on the use of interest rates and QE in managing economic cycles.

Glossary

• Bank Rate: The interest rate at which the Bank of England lends to commercial banks, influencing overall economic activity.
• Forward Guidance: A central bank policy tool involving communication about future monetary policy intentions.
• Inflation Target: A specified rate of inflation that a central bank aims to achieve to maintain price stability.
• Monetary Policy Committee (MPC): The body within the Bank of England responsible for setting interest rates and other monetary policies.
• Quantitative Easing (QE): A monetary policy tool where the central bank purchases financial assets to increase the money supply and lower interest rates.