Dealing with a Banking Crisis: Monetary Assessment and Strategy Division - Assignment Example

MACRO AND MICRO ECONOMICS Question: Identify the most appropriate variables used to analyze pre and post crises of Bank of England. For each of them create the appropriate tables or graphs which can help to derive your analysis. Comment on the extract of speech from the governor. Word count: 2123 1. Introduction The goal of monetary policy is to maintain the value of money relative to the goods and services it is used to purchase. In the past times, monetary policy has taken various forms, but most recently it has been associated with price stability objectives usually accompanied by inflation targeting frameworks. Generally, under inflation targeting central banks aims to support growth by maintaining stability besides minimizing the variability of inflation and output. Specifically, monetary policy in the United Kingdom has operated under flexible inflation targeting since 1992(Command of Her Majesty 2013, p3). This was as a result of response to previous and high volatile inflation that turned out to be economically and socially costly. This term paper thereby looks into the variables used to analyze pre and post crises of the Bank of England and perception of the speech given by Mark Carney the governor of the Bank of England. 1.1Pre-crisis# England’s equity and property market booms ended in 1991-94 after monetary policy was tightened following a period of low interest rates and the banking regulator introduced a new policy to control real estate lending. This was followed by a lost decade characterized by slow economic growth and financial instability. The banking regulator at first responded with a policy of regulatory forbearance which means refraining from forcing banks to recognize their losses promptly. But after the crisis turned out the authorities undertook public capital injections and set transparent regulatory patterns to boost and improve disclosure besides provisioning of non-performing loans. Following a collapse in equity and property prices in the early 2000s, England underwent a financial sector distress culminating in a full blown systemic banking crisis. The long period of economic stagnation accompanying financial sector distress divided economic opinion and prompted fierce debates. The bank of England showed that it had the ammunition to attack the economic crises at its worst moment in 2009 when it printed 375 billion euros for new money and pumped it into households and company bank accounts through the purchase of government bonds. Yet five years later, the merits of quantitative easing still divide economic opinion and emerging debates are far from being solved (Giles 2014, p1). Since 2008, the unprecedented level of monetary that the bank of England has engineered as a response to the global financial crises has unleashed approximately $9.5 trillion. This looked like a collective response in the sense that central banks in the advanced economies faced similar conditions and followed expansionary paths as their economies were characterized by recession, credit crunch, budget deficits and ballooning public debt. In reality, however, these central banks have been acting together more by chance than by design, following quite different approaches and following quite different ideas under the unifying mantra of “going beyond the zero bound” and “thinking the unthinkable”, while making policy against correct expectation that others would be following similar policies. Most of all they have been acting on domestic grounds, with little coordination in terms of accepting the spill over of the impact of the huge additional liquidity they put into the system (Subbachi 2005, p88). As the interest rates became close to zero in the pre-crisis, the search for solution became more frantic. In 2012, England faced sort of a re-run to the pre-crisis year of the “Great Moderation” when low inflation and low interest coupled with the saving glut in some parts of the world imposed excessive debts and leverage and more risks. However, if world markets are back to pre-crisis years currently, the world economy is not. In 2005-2006 the world economy grew at the annual rate of 5% while the USA, UK and the Eurozone grew at 2.9, 2.7 and 2.5 percent respectively. Today growth is insufficient as there is insufficient and incompetent increased spending in surplus countries coupled with fiscal retrenchment in deficit countries (Subbachi 2005, p89). 1.2 Post-crisis# Resolving uncertainty over banks assets valuations and recapitalizations were crucial in restoring market confidence. In England this required detailed and repeated supervisory inspections based on transparent loan classification and provisioning standards. The need to rekindle economic growth in England to avoid financial collapse has pushed central bank towards more active monetary policy and more aggressive language. They have descended from the ivory towers and joined the fight against deflation and stagnation. For instance through adopting non-conventional measures such as the various forms of quantitative easing (QE).The Fed resolved to QE in late 2008 as nominal interest rates the conventional ,measures could not be further lowered because they cannot be negative. Since then liquidity has been injected in faltering economies through the purchase of financial assets in the market in order to lower the cost of borrowing. The sovereign debt crisis in the Eurozone in July 2012 Mario Draghi the European Central Bank promised whatever it takes to save the euro to calm the markets down. In England many expected a sudden and immediate change in the approach to and in the stance of monetary policy at the BoE and at the end to the purchase of assets that took place in 2009 which was undertaken to inject money directly into the economy so as to improve and boost the nominal demand. The economy however is recovering at a slow pace and broader sets of financial conditions are not quite yet for exiting ultra-expansionary monetary policy. The issue at hand is rather on how to achieve more traction and effectiveness out of the existing QE and other measures such as funding for lending. In addition the government recognizes the UK economy and like any other advanced economies it currently faces many exceptional challenges in securing and sustaining post crisis recovery and rebalancing the economy after a decade of growth established and built on an unsustainable levels of debt. Central bank’ main conventional policy instrument, the short-term nominal interest rate is currently at the effective lower bound in several advanced economies like the USA. This potentially puts a floor under real interest rates in the economy. These challenges continue to test the consensus on macroeconomic policy making (Command of Her Majesty 2013, p3). Putting into consideration the approaches of monetary policies across advanced economies since global financial crisis in 2008-2009 is important. Monetary policy has been used to move beyond conventional instruments in order to back up economies through exceptional challenges. Different central banks have used various forms of unconventional instruments in order to create further policy easing. This has established and provided a wider variety of interventions against which to consider the operation of monetary policy in the UK. The performance of flexible inflation targeting over more than 20 years in advanced economies set a high standard for change, as the Chancellor of the Exchequer explained at the Treasury Committee in December 2012; this review examines some of the merits, drawbacks and risks of inflation targeting frameworks including various elements of flexibility, relative to other monetary frameworks. Based on the assessment of this review, the government concluded that further updating of the remit set for the independent monetary policy committee (MPC) of the bank of England is appropriate. The remit of the MPC at the budget of 2013 in a part of Government’s economic strategy consisted of monetary activism and credit easing, stimulating demand, maintaining price stability and supporting the flow credit in the economy; a comprehensive package structural reforms rebalancing and strengthening the economy for the future including an ambitious housing package and a programme of infrastructure investment; reform of the financial system improving the regulatory framework to limit risks to the taxpayer and build the resilience of the system and finally deficit reduction while returning the public finances to a sustainable position and ensuring fiscal credibility underpins long-term interest rates. Generally as the world’s economy though banking and finance has become more interconnected hence more complex, there is a need for policy framework to solve and manage these complexities and to account for the spillovers or the negative externalities that a country’s policy may generate on another country. This is a fundamental lesson learnt from the global financial crisis. Therefore risks of world economy and financial stability have increased. 1.3Variables# In analysis of the two periods, the most appropriate variables to be considered for pre-crisis period include: Net foreign assets and output losses whereas those to be considered in the post crisis period include: Gross external debt in advanced market economies. Graph 1 Key Column 1: Advanced economies, Series2: Emerging market economies 2 Governor of Bank of England Speech Considering a new face in the bank of England and his speech, I think Mark Carney seemingly has managed to take England to a new dynamic as compared to the past decade. His focus is to drive the bank policy on non-inflation target so as the central’s banker’s primary goal would be to price stability. He states that since August inflation has fallen back to target for the first time in five years and unemployment has fallen rapidly towards 7% thereby achieving one of his visions. Before the crisis the growth in potential supply was largely predictable and as a consequence, central bankers responded to movements in demand around that trend (Benjamin 2014.p39) Mark is concerned with the labor force and its poor performance as compared to the United States, which is concerned with labor force participation rates. I believe raising interest rate by7% gives a chance for the economy to grow. Last August the Bank’s monetary policy committee made an easy call: We wouldn’t even begin to think about raising interest rates until the unemployment rates fell to 7%. Given the weakness of the UK recovery and the flexibility of the labor market, expectations that considerable slack would ensure that the MPC was not at any risks to inflation as policy encouraged faster output and employment growth. I support Carney’s view when he says that the world was fatally flawed via enormous innovations of enduring value during the period of Gordon Brown. This is because the focus of the bank at that time was to set interest rates focusing on an inflation target. I believe that changes must be made to both the hard and soft infrastructure of core markets to ensure that they are fair, effective and efficient .In addition, his comment on the maintenance of recovery is brilliant because productivity gains should be at their maximum. This is evident in the part where he quotes the latest data showing that more than a quarter million jobs were created in a three month period producing a big increase since records began in 1971. As a result, unemployment seems to be ceasing at a pace that will reach the 7 % threshold materially earlier than had been expected. However, I tend to disagree with the rate of the decrease because it’s a little higher as most parts of England still face unemployment. He quotes that” unemployment remains above the level that is likely to be consistent with maintaining inflation at the target in the medium term. It’s not just that nearly three quarters of a million people are out of work than before the crises; another three quarter of people are involuntarily working part time (Hellion, 2012 , pg 43). Indeed, the fact that underemployment is exerting downward pressure on costs is true and this also reflects better than expected performance on the supply side of the labor market. In the jargon the extent to which underemployment has hysteresis seems to have been less than in past recessions. The attainment of the 7 % threshold, however may not be associated with an immediate need to raise bank rates, because this will hold back imported inflation pressures. 3 Conclusions# There are various economic interpretations of the correlations uncovered by the simple regressions in the graphs. One is that weak lending growth is the aftermath of banking crisis, especially in their weakest capital positions or incurring heavy losses following the crises. Equally banks with stronger liquidity positions may have been better able to access funding in the wake of the crisis as their balance sheets were to a greater degree shielded in the fall of collateral values that existed throughout the period. Reference Benjamin, N. (2014) Dealing with a banking crisis: Monetary assessment and strategy division. P37-41 Command of Her Majesty (2013) Review of the Monetary Policy Framework.print.p3-4 Giles, C. (2014) Economy: “Merits of Banks of England’s QE still spark debate 5years on.”p13 Subbachi, P. (2005) “Coordinating the next move: Monetary Policy in the Post Crisis World.” Research on international Economics.p88-89 Hellion, K (2012). Banking. The Bank of England. Read More