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The role of the bank of England in the last two years Essay

Established in 1694 and nationalized in 1946, the bank of England performs all the functions of a central bank in the UK. In its capacity as a central bank, the bank performs a number of functions among them being • 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 (Brentworth, 2008, pp. 100)

Currently headed by Mervyn King, its main operations are carried out by the bank’s Monetary Policy Committee (MPC) which decides on the interests rates to apply in the economy as guided by existing market conditions. Such interest rates decided by the bank impact heavily on all the areas of the economy mostly felt in domestic monetary markets (lending figures, share market, housing prices etc), exchange rates statistics, demand and output data and the labor market which all combine to determine economic growth.

Judging by the impact that the activities of the bank on the various markets, this paper discusses the performance of the bank in the last two years as a failure. Again, the projections of the bank for the next two

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years are analyzed in deep showing that the next two years have nothing more promising other than that the already bad situation economic wise is going to persist. Failed policies The estimation by the bank of a 2% inflation rate for the 2008 -2009 financial period has been trashed by experts as a political gimmick after the same level of 2% estimated in 2006 was missed massively with inflation standing at 4.

7% in October. As the one of the largest economies of the world, the world is currently watching eyes wide open the financial and economic path that Britain and the larger UK is going to take following the financial crisis in America at the moment. On the spotlight is Mervyn King, head of the bank. This comes hot on the heels of the bank being criticized over the accuracy of its forecasting of Consumer Price Index (CPI) inflation over the past two years. The prediction made by the bank way back in 2006 of expected CPI inflation in 2007 and 2008 being 2 % proved to be very wrong with actual CPI inflation for 2008 hitting 4.

7%. The same prediction of 2% had been made for the 2004 to 2008 period which still was not accurate. In the month of June, unemployment rates were announced to have reduced according to the Bank (Brentworth 2008, pp. 122). Empirical evidence according to daily papers is pointing at the opposite. The month has seen the number of economically inactive persons increase to the second highest level ever at 21. 2%. The highest recorded level was in 1997 which stood at 21. 6%.

This percentage constitutes the number of persons in the working-age population that is not working either voluntarily, or involuntarily. The figures presented by the Office of National Statistics indicate that unemployment levels have reduced by 45, 000 persons in three months to stand at 1. 65 million people. Observers say that this number only constitutes those who seek unemployment benefits. They cite that there is a number of unemployed persons who do not seek the benefits but depend on someone else or rather they seek other forms of benefit such as the incapacity handouts.

They say that the Bank of England does not take into account current events that are happening now which are the very same reasons that have led to the relatively high inflation levels experienced in the past two years, (Wilkins, 2007, pp. 87: Aron and Thame, 2008, pp. 37) Since early last year, the country has been experiencing an increase in nominal wages. This has led to households oblivious of the knowledge of inflation to increase their spending in the belief that they are making more money than before.

Unfortunately when these wages are adjusted to the inflation rates to get the real wages, they realize that their real increase in wages has actually been falling. A leading financial adviser Brandon May as quoted by Brentworth (2008, pp. 122) has noted the good thing about this trend of ignorance on the part of the households is that consumer demand will hold up for some time. He says that the current fall in consumer spending is not as a result of the knowledge of the plight that they have in their hands of lesser disposable income.

He attributes the fall as a reaction of the events taking place in the US as households fear that the same scenario might be experienced back home. Inflation as measured by the Retail Price Index stood at 4. 5% in April 2007. This level has been maintained into this year with only minor fluctuations. Growth in take-home pay in the UK has been slowing and has remained below the Retail Price Index (RPI) for the second half of this year. (Brentworth, 2008, pp. 122). Thus it would seem that with consumers realizing where they stand, then consumer demand will fall further. How can the Bank of England come to the rescue of the situation then?

The credit crunch that hit the global banking system did not spare some banks in England either though in relatively minor degrees. The Northern Rock bank was early in November last year faced with the credit problem leading to panicky customers making hasty withdrawals from the bank. The Bank’s governor had earlier stated that the bank would not move in to save banks faced with the crisis the way the Federal reserve bank of the US had done. However, the governor retracted his words and came into the rescue of the bank but relatively late as depositors were already not confident enough with the bank to trust them with their money.

This could have been avoided if the bank had responded early enough. Take home pay among UK working class citizens is declining according to Voca. This is compounded by the fact that inflation is on the rise and there is a general increase in the cost of living. < http://www. euromonitor. com/UK_consumer_pay_packets_under_pressure> UK citizens seem to be on the losing side as compared to the rest of Europe. The largest economy in Europe is the worst by high inflation as of March 2007 which stood at 3. 1% compared to the rest of Europe which averaged at 2. 2%. Bank of England 2 year Inflation forecast

2004 05 06 07 08 09 2010 The bottom line is that markets, by nature, are erratic and unpredictable as shown by the market forecast which is more realistic. However, this should not be used as a scapegoat by the Bank of England over the failure of the bank to foresee the possible financial trends going by the market conditions and institute appropriate measure. The credit crunch that faces America should sound warning bells to the Bank and in the process institute effective measures to fully address any negative possible outcomes.

Therefore, the Bank of England has failed in protecting her people from financial worries and panicking that could have been easily avoided had the right measures been put in place. Macroeconomic policies Is this year’s current credit crisis comparable to the 1929 stock market crush in the US? Are we headed to another great depression? These are some of the major fears that are deteriorating the already worse situation in the UK and the whole globe. Markets are registering minimal to negative growth in fear of the coming years.

Consumption by households is falling; depositors are making hasty withdrawals; investors are shying away from the stock markets; employment levels are on the decline; the housing and mortgage departments are on the verge of collapsing. The world is in a crisis we admit or we don’t. What are some of the macroeconomic policies that the Bank of England in its capacity as the country’s central bank employing to revert the situation? Cuts in interest rates The relationship between the labor and financial market has drawn a lot of researchers into the discussion of the effectiveness of this policy.

The question has been, is a growing financial market capable of improving the labor market? Market liberalists believe the answer is yes. Their argument then would translate that a failing financial market leads to the collapse or decline of the labor market. The main point in their argumentation is the “complementarity hypothesis” which promotes the complementarity between money and physical capital in less developed countries” (Melvin, 2007, pp. 256). Increase in inflation and the high cost of living have driven a number of previously economically inactive individuals into seeking employment in a bid to make life bearable.

As earlier noted these economically inactive individuals consist of employed people but on leave from work due to illnesses or other factors, students and those in uneconomical employments. However, Jason (2007, pp. 245) notes that with life becoming expensive, students are to seek employments to make ends meet thereby reducing the proportion of these economically inactive persons. On another from the financial markets are expecting the interest rates to fall further than the current 4. 5% before the year ends. Our monetary policy framework is, as the governor pointed out in his Mais lecture three years ago, based on “constrained discretion.

Inflation will come back to its 2% target – a credible commitment. But there is also “discretion about the horizon over which inflation is brought back to target. ” http://news. bbc. co. uk/1/hi/uk_politics/7698339. stm The Bank of England is supposed to operate independently away from government and political interference. Nevertheless, the government sets the inflation target (currently CPI inflation of 2 per cent) but the convention has been that the state does not lean on the Monetary Policy Committee when it comes to making interest rate decisions consumer spending and GDP growth in the UK in the last two years (2006-2008).

(Wilkins, 2008, pp. 76) Consumer spending and GDP growth in the UK 2006-2008 2005 06 07 2008 Despite the fear that has gripped the market, households are responding to the credit crisis rather late. The US market has endured a slump in consumer spending for the better half of 2007 and 2008. Fortunately the bug is only hitting the UK market this year against earlier prediction that it was going to happen concurrently with that of the US market according to the The Sun’s predictions.

From the graph it seems that households were responding to the fears that a similar scenario in the US would be experienced in the UK. The Bank of England has responded by cutting down interest levels further to 4. 5% from a high of 5. 75% in October 2007. http://news. bbc. co. uk/1/hi/business/7146936. stm References Melvin, B. (2007), Investing in the UK stock markets, Economic Journal, March, pp. 483-496. OECD (2007), Economic Outlook, (November, Paris) Jason, F. (2007) Introduction to the UK markets, (London, Pearson)

Brentworth, Rawland, (2008), The UK economic structure, (London, Macmillan) Wilkins, K. (2007), The making of a depression, (London, Penguin) Aron, P. and Thame, Y. (2008), The Credit crisis in America: where the rest of the world stands, (Birmingham, Talons) Information on the above also available at, Household consumption at, http://www. euromonitor. com/UK_consumer_pay_packets_under_pressure, (Retrieved on 5. 11. 08) BBC news at, http://news. bbc. co. uk/1/hi/business/7146936. stm, (Retrieved on 5. 11. 08) http://news. bbc. co. uk/1/hi/uk_politics/7698339. stm, (Retrieved on 5. 11. 08)

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