monetary policy

The natural rate of interest

The natural rate of interest

The natural rate of interest is the interest rate consistent with maintaining economic growth at its trend rate and stable inflation. Another definition of the natural rate of interest is: “the real interest rate consistent with real GDP equalling its potential level (potential GDP) in the absence of transitory shocks to demand. (FR) In other words the natural rate of interest is that interest rate which causes neither overheating (boom) or lack of demand (recession). Monetary policy is essentially concerned with finding the natural rate – because that will give…

Base rates and bank interest rates

Base rates and bank interest rates

The Bank of England set the base rate. This is the rate at which they charge commercial banks to borrow from the Bank of England. In normal economic circumstances, this base rate will influence all the interest rates set by other banks and financial institutions.If the Bank of England cut the base rate, you would expect banks to also cut their mortgage and lending rates. If the Bank of England put up the base rate, you would expect banks to increase their mortgage rates.

Quantitative easing: Risks vs benefits

Quantitative easing: Risks vs benefits

Readers Question: Could you comment on This BBC programme on Q.E. The programme highlights several criticisms of Quantitative Easing, especially the Q.E. adopted by the Bank of England. Since 2009, the Bank of England’s balance sheet has quadrupled, and now a third of all government bonds are now held by Bank of England. The programme fears this is storing up future inflation and a possible loss of confidence in the bond market. Firstly, just to recap: Quantitative easing involvesCentral Bank creating money electronically Using this electronic money to purchase bonds (mostly government bonds)The…

UK Unemployment Target

UK Unemployment Target

The new Bank of England governor, Mark Carney, has implemented a type of unemployment target. As part of forward guidance, the Bank of England state that: Interest rates won’t rise from 0.5% until unemployment falls below at least 7%. Essentially, the bank are committing to expansionary (loose) monetary policy until there is a stronger economic recovery and unemployment has fallen. The hope is that the commitment to low interest rates will encourage firms to invest and consumers to spend. However, this unemployment target of 7% has a few caveats.  The unemployment target…

Forward guidance in monetary policy

Forward guidance in monetary policy

Forward guidance is when the Central Bank announces to markets that it intends to keep interest rates at a certain level until a fixed point in the future. The aim of forward guidance is to influence long term interest rates and market expectations. For example, the Central Bank might want to boost economic activity by convincing markets that interest rates will stay low for the foreseeable future. It means that Central Banks are pledging to keep interest rates low, even if inflation starts to creep above its target. It can be…

Credit Policy

Credit Policy

Credit policy / financial policy is the use of the financial system to influence aggregate demand (AD). Monetary policy affects AD through the Central bank controlling interest rates and the money supply. Fiscal policy affects AD through the use of government spending and taxation. Credit policy looks at factors such as:Bank lending rates to firms and households in the economy. The supply of credit and availability of loans from banks to firms and households.In normal economic circumstances, it was felt the Central Bank could adequately control the economy through…