The Role and Responsibilities of the Central Bank of the UK - Literature review Example

The role and responsibilities of the Central Bank of UK: literature overview Introduction The Central Bank of England is a centre of world finance, a sign of public credibility and stability. The attention of the scientists, economists and researchers to the Central Bank of England is reflected in numerous books, journal articles, researches, economical analyses etc. This research paper is based on consideration of the main works on Bank’s roles and responsibilities. With regard to the most significant changes in the Bank, economists consider the Bank from different perspectives. Therefore, on the basis of literature overview (30 sources) this paper discusses the Central Bank of UK, its roles and tasks. Outline: A) Introduction B) General discussion: 1) The Bank of England: duties and responsibilities; 2) Past and present tendencies towards the Bank of England; 3) Governmental attitude to the Central Bank of England ; 4) Suggestions about the Central Bank’s changes. C) Conclusion. The Bank of England: duties and responsibilities The Bank of England has numerous tasks of a central bank, such as: Price stability maintaining; UK Government economic policies’ support. On the basis of the performance of these two functions, the Bank of England reflects efficiency of its actions on monetary stability and financial stability. Monetary stability ensures currency reliability and prices’ stability. Financial stability is concerned about security of financial system in general (Geraats, 2002). Balls (2002) states that “in order to ensure monetary and financial stability, the Bank of England cooperates with HM Treasury, the Government department of financial policy and economics, the Financial Services Authority (an independent organization, which that regulates the industry of financial services) and other central banks on international level” (Balls, 2002). The Bank of England has also many other duties, such as management of exchange rate and gold reserves, management of other banks of England etc. According to Balls, “the Bank of England acts as the Government’s banker, and as such it maintains the Government’s Consolidated Fund account. It also manages the country’s foreign exchange and gold reserves, performs function of a lender of last resort etc” (Balls, 2002).Furthermore banknotes issue is a monopoly of the Bank of England. Past and present tendencies towards the Bank of England In 1997 there was a shift in the Bank’s functions and responsibilities: the Bank was given a monetary independence. Monetary role of the Bank can be an essential contradiction to its other roles. Consequently, the attention of the economists and scientists to Bank’s independence is reflected in the articles discussed below. On the one hand, monetary policy of the Bank of England is criticized (Geraats, 2001; Chortareas, 2002). The arguments of criticism are the following: UK’s withdrawal from EMS has questioned Bundesbank’s ability to cope with monetary policy (Issing, 1999). Nevertheless, UK justifies its monetary role and underlines its unbiased basis, unlike monetary policy of Bundesbank, which underlined its domestic objectives. A strict criticism is also expressed by the researchers, who claim that membership of the EMS was more favourable for the Bank of England, than Bank’s independence (Blake, 1993; Blinder, 1998). Thus Barro and Gordon (1983) support the idea of monetary authority of the Bank, but underline the necessity of certain reforms and institutional changes. Rogoff (1985) criticizes Bank independence because of potential political contradictions between a central banker and policymaker. There are also supporters of monetary authority of the Bank of England. Thus, Blake (1993) on the example developed for a small numerical model proves that monetary authority is the most beneficial authority in the development of bank polices (Hansen and Hodrick, 1980). Monetary policy of the Bank of England is considered to be a weak point because of unstable economic grounds. Therefore it is also claimed that a combination of a fiscal and monetary policy is more beneficial (Nickel, 2005). The independence of the Bank of England is also considered from another perspective, where an emphasis is made on inflation targeting of the Bank: “The thirty-year search for a nominal anchor to replace the Bretton Woods system seems to be over”(Goodhart, 2006). Therefore an improvement of UK monetary policy occurred because of inflation targeting. The most positive result of the Bank independence is a right of setting interest rates (Cook, 1990). The Monetary Policy Committee is often supported by the fact that if times are tranquil and there are no domestic changes then MPC is able to cope with the situation and conduct monetary policy. On the other hand, an increase of oil price may lead to MPC’s hardships (Wickens, 2006). Moreover, the fact that MPC has tended to forecast inflation and suppress output date is another claim of critics (Dotsey, 1987). Therefore critics claim that “…interest rates may have been set too high, but had the output forecasts been more accurate, interest rates might have been set even higher” (Maxwell, 2000). The Bank of England is often accused of errors in forecasting the exchange rate, prognosticating GDP data thus leading to a spoiled reputation of the Bank (Clements, 2004; Cukierman, 1986). With regard to the sources considered above, the role and responsibilities of the Central Bank of UK are considered with reference to previous years and to current tendencies. A consideration of future prospects of the Central Bank is focused on maintenance of its track record of achieving inflation targeting; support cooperation with MPC; management with regard to the changeable nature of inflation etc. These issues are covered in the works of recent years (Faust and Svensson, 2002; Geraats, 2002; Goodhart, 2006). Moreover, there is a great attention paid to governance improvement in the Central Bank (Wallis, 2004) in order to prevent crisis consequences. Along with this issue, a consideration of establishment of audit committees is developed (Nickell, 2005). The roles and responsibilities of these committees should be well-developed and defined in order to control over the Central Bank monetary policy and other activities. This idea has a strong background, because public confidence in the Central Bank is a guarantee of Bank’s deposits and increase of financial resources. Therefore for any Bank it is appropriate to involve independent external auditors in order to show their transparent policy and efficient work (Rudin, 1988). Governmental attitude to the Central Bank of England Another discussion of roles and responsibilities of the Bank of England concerns Bank’s statuary responsibility for the failures of payment systems (in accordance with Banking Act 2009). The Bank is also a perfect regulator of certain payment systems (Treasury, 1997). Furthermore the Bank of England guarantees the designating authority for stand-alone payment systems, working in compliance with the Financial Markets and Insolvency Regulations. From a political perspective, a consideration of the Bank of England is generally presented in the following way: “…the Bank has a lot of skill and resource, as also does the FSA” (Rafferty, 2002). This phrase of Lord Myners in his interview to BBC2’s Newsnight supports the claim that politicians consider the Bank’s independence to be a justified and well-weight decision, favourable for Government, society and economy of the country (Dotsey, 1987). In such a way, Bank’s performance is constantly improved, regulated and supported by the Government, being a guarantee against a lack of failures and banking collapses. Of course, there is no certain guarantee against Bank’s collapses avoidance in the future; through proper and qualified governance and supervision it is possible to decrease the risk of banking collapses, but not to prevent them (Lohmann, 1992). At this point, the Bank of England is more responsible for preventive measures and proper governance (Muller and Zelmer, 1999). Banking is a risky activity and no matter what the status and reputation of the Bank are, there is still a risk of collapse (King,1997). The Bank should be able to look for golden mean between safe public services’ provision and avoidance of economic destruction because of inflation. Furthermore it is relevant to mention works devoted to discussion of the Bank of England under circumstances of the world crisis. The main strategy chosen by the Bank and Government is an increase of loans issue to small and large businesses (Wallis, 2004). This approach can be proven in such a way: “If there was a significant shortage of credit, overdraft utilization rates would rise. They have not risen. They have remained very stable” (Wallis, 2004). Suggestions about the Central Bank’s changes It was already mentioned, that the Bank of England plays the role of Lender of the Last Resort. This role has been assigned to the Central Bank, because of FSA inability to provide a credit line, such as the Liquidity Support Facility. The Bank has the resources, but unike FSA it doesn’t have information on other banks’ liquidity and solvency (King, 1997).This responsibility is risky for the Central Bank, but it provides LOLR facility though has a lack of necessary information. Therefore there is a necessity for the Central Bank to cooperate with other bodies in order to fulfill its roles and responsibilities appropriately. The following example of tripartite cooperation witnesses its efficiency: banking supervision and regulation is delegated from FSA to the Central Bank. The FSA is concerned about customers’ protection and takes care of retail issues; the Treasury is concerned about deposit protection/insurance/guarantees, with a proper informing of the Central Bank in case of any changes. In such a way, the Bank turns into an efficient LOLR function. Nevertheless, a LOLR function of the Bank is complicated by the political context of such kind of operation (e.g. the Northern Rock case) (Kehoe, 1989). Moreover, LOLR function ties such issues as property rights/ distribution of wealth/income. The Treasury compensates losses of insolvent LOLR operations to the Central Bank. There are supporters of the Bank independence, who claim that in terms of domain of monetary policy, there is still a deep involvement into political LOLR operations (Goodhatrt, 2006). Other ideas are expressed with regard to MPC withdrawal from the Bank of England. This point has already been discussed above, but in this section it has a different context. The MPC withdrawal is considered also from the following point of view: the same mandate price stability, high level of employment etc will be present in MPC. The Bank is considered to be an agent of MPC, who “…uses its money market and repurchase operations in the overnight market to keep the overnight rate as close to Bank rate as possible” (Goodhart, 2006). Other Bank’s functions, such as the Standing Lending and Deposit Facilities, activity on the market, foreign exchange market etc would be of the Central Bank concern. Therefore the Central Bank’s workload is intensified because of its LOLR responsibilities for individual banks and liquidity provision for other foreign markets (Pagan, 2003). Furthermore, a vivid discussion takes place around FSA consideration performing LOLR functions. Therefore this model suggests passive role of the Bank in performance of LOLR functions with an active involvement of FSA as the Bank regulator. Thus FSA would be having a credit line with the Bank of England, ensured by the Treasury, in order to prove the solvency of the Bank’s financial resources. This suggestion is often supported by the economists and scientists, because it is the way to ensure banking failures (Kehoe, 1986). It can be clarified by the fact that information required for LOLR function performance is available for the organization, which will perform LOLR function. Conclusion A literature review is based on consideration of modern and recognized contributors’ works. This research paper is founded on consideration of the main works on Bank’s roles and duties. With reference to the most significant changes in the Bank, scientists consider the Bank from different perspectives. The role and responsibilities of the Central Bank of UK are considered with reference to previous years and to current tendencies. A consideration of future prospects of the Central Bank is focused on maintenance of its track record of achieving inflation targeting; support collaboration with MPC; administration with regard to the unpredictable nature of inflation. These problems are covered in the literature of recent years. This paper has justified the importance of the Central Bank of England and its discussion. We can see that Bank’s performance is constantly improved, synchronized and supported by the Government, being a guarantee against a lack of failures and banking collapses. Certainly, there is no certain guarantee against Bank’s fails prevention in the future; through appropriate and qualified governance and supervision it is possible to decrease the risk of banking collapses, but not to prevent them. The Bank of England has also many other responsibilities and important tasks, such as management of exchange rate and gold reserves, management of other banks of England etc. The Bank of England fulfils the task of the Government’s banker, and thus it controls the Government’s Consolidated Fund account. It also regulates the state’s foreign exchange and gold reserves, performs function of a lender of last resort etc. The Bank is also a perfect manager of certain payment systems (Treasury, 1997). Moreover, the Bank of England guarantees the designating authority for stand-alone payment systems, working in compliance with the Financial Markets and Insolvency Regulations. A vivid discussion about monetary policy of the Bank, tripartite cooperation with MPC and Treasury, Bank’s strategies of inflation targeting and other issues are of primary concern for the economists and scientists. In terms of globalization, it is relevant to support independence of central banks though their considerations about governmental claims and possibility of economic crisis. Monetary policy of the Bank and LOLR function of the Bank are also widely discussed by the economists and scientists. Consequently, the independence of the Central Bank of UK and its efficient work as an independent bank has proven relevance and efficiency of this decision. Works cited 1. Balls, E. and O'Donnell, G., 2002. Reforming Britain's Economic and Financial Policy. Palgrave. 2. Barro, R.J. and Gordon, D.B., 1983. Rules, discretion and reputation in a model of monetary policy. Journal of Monetary Economics, 12, pp. 101-121. 3. Blake, A. P., 1993. Should the Bank of England Be Independent. National Institute Economic Review, 143, p. 72+. 4. Blinder, A. S., 1998. Central bank independence in theory and practice. Cambridge, MA: MIT Press. 5. Cecchetti, S. G., and Krause, S., 2002. Central bank structure, policy efficiency, and macroeconomic performance: Exploring empirical relationships. Federal Reserve Bank of St. Louis Review, 84, pp. 47-60. 6. Chortareas, G., Stasavage, D. and Sterne, G., 2002. Does it pay to be transparent? International evidence from central bank forecasts. Federal Reserve Bank of St. Louis Review, 84, pp. 99-118. 7. Clements, M.P., 2004. Evaluating the Bank of England density forecasts of inflation. Economic Journal (forthcoming). 8. Cook, T., and Hahn, T., 1990. Interest rate expectations and the slope of the money market yield curve. Federal Bank of Richmond. Economic Review, 76, pp. 3-26. 9. Cukierman, A. and Metzler, A. H., 1986. A theory of ambiguity, credibility, and inflation under discretion and asymmetric information. Econometrica, 54, pp. 1099-1128. 10. Dotsey, M., 1987. Monetary policy, secrecy, and federal funds rate behavior. Journal of Monetary Economics, 20, pp.463-74. 11. Faust, J. and Svensson, L., 2002. The equilibrium degree of transparency and control in monetary policy. Journal of Money, Credit and Banking, 34, pp. 520-39. 12. Maxwell, F. et al., 2000. Key issues in the choice of monetary policy framework. In Monetary policy frameworks in a global context. Ed. by Mahadeva, L. and Sterne, G. New York: Routledge, pp. 1-216. 13. Geraats, P. M., 2001. Transparency of monetary policy: Does the institutional framework matter? Unpublished paper, University of Cambridge. 14. Geraats, P. M., 2002. Central bank transparency. The Economic Journal, 112, pp. 532-565. 15. Goodfriend, M., 1986. Monetary mystique: Secrecy and central banking. Journal of Monetary Economics, 17, pp. 63-92. 16. Goodhart, C.A.E., 2006. An essay on the interactions between the Bank of England's forecasts, the MPC's policy adjustments, and the eventual outcome. Journal of Central Banking Studies (forthcoming). 17. Hansen, L.P., and Hodrick, R. J., 1980. Forward exchange rates as optimal predictors of future spot rates: An econometric analysis. Journal of Political Economy, 88, pp. 829-53. 18. H.M. Treasury, 1997, The Inflation Target and Remit for the Monetary Policy Committee: Background Notes, H.M. Treasury. 19. Issing, O., 1999. The eurosystem: Transparent and accountable or 'Willem in Euroland'. Journal of Common Market Studies, 37, pp. 503-20. 20. Kehoe, P., 1989. Policy cooperation among benevolent Governments may be undesirable. Review of Economic Studies, 56, pp. 289-296. 21. King, M., 1997. Changes in UK monetary policy: Rules and discretion in practice. Journal of Monetary Economics, 39, pp. 81-97. 22. Lohmann, S., 1992. Optimal commitment in monetary policy: Credibility versus flexibility. American Economic Review, 82, pp. 273-286. 23. Muller, P., and Zelmer, M., 1999. Greater transparency in monetary policy: Impact on financial markets. Technical Report 86. Bank of Canada. 24. Nickell, S., 2005. Practical issues in UK monetary policy, 2000-2005. British Academy Lecture. 25. Pagan, A.R., 2003. Report on modeling and forecasting at the Bank of England. Bank of England Quarterly Bulletin, 43, pp. 60-88. 26. Rafferty, M. C., and Tomljanovich, M., 2002. Central bank transparency and market efficiency: An econometric analysis. Journal of Economics and Finance, 26, pp.150-61. 27. Rogoff, K., 1985. The optimal degree of commitment to an intermediate monetary target. Quarterly Journal of Economics, 100, pp. 1169-1189. 28. Rudin, J. R., 1988. Central bank secrecy: 'Fed watching', and the predictability of interest rates. Journal of Monetary Economics, 22, pp. 317-34. 29. Wallis, K. F, 2004. An Assessment of Bank of England and National Institute Inflation Forecast Uncertainties. National Institute Economic Review, 189, p. 64+. 30. Wickens, M., 2006. The Bank of England's Monetary Policy Committee: A View from a Parliamentary Specialist Adviser. National Institute Economic Review, 196, p. 77+. Read More