Civil Engineering Reference
In-Depth Information
Monetary Policy
Monetary policy
is implemented in most countries by a
central bank
, such as the
Bundesbank in Germany, the Federal Reserve in the USA and the Bank of England.
In the UK, prior to 1997, monetary policy was set by the government - in other
words, the Bank of England simply followed government instructions. In May
1997, the government established a new monetary policy framework, transferring
operational responsibility to an independent
monetary policy committee
(MPC).
The committee is responsible for monetary and financial stability. In this role it sets
interest rates each month and provides support for economic growth via a system of
quantitative easing
. The overall measure of the MPC's effectiveness is judged by its
ability to maintain the government's overall inflation target. At present, the target is
for a 2 per cent increase in the annual consumer price index. (A fuller account of the
work of the MPC and the measurement of inflation is explained in
Chapter 14
.)
The monetary policy committee consists of ten experts drawn from outside
and inside government circles. At the monthly meetings, the panel of experts carry
out in-depth analysis of a wide-ranging set of data. Published monetary policy
committee minutes (extracted from the Bank of England's monthly
Inflation Report
)
suggest that the analysis includes the general state of the world economy, trends in
domestic demand, the labour market, the housing market and the financial markets,
and last, but by no means least, various measures of inflation and costs in specific
sectors of the economy. The committee works from the premise that interest rates
represent a general cost of activity and, therefore, after allowing a period of time to
transmit through the economy, interest rates ultimately control the level of prices,
funding liquidity, and aggregate demand.
To enable the Bank of England to concentrate on issues relating to monetary
stability, responsibility for supervising individual financial institutions was handed
over to a newly created Financial Services Authority in 1997. This separating of
functions survived a decade of economic stability (from 1998 to 2007), however
serious problems in the banking sector caused by the credit crunch led to global
calls for a greater regulation of the financial system. In particular, high street
banks needed to be safeguarded from the riskier activities of their investment arms.
As a consequence, regulators around the world have strengthened their rules and
raised the level of capital required by banks to back up their assets. The UK plans
legislation to separate the high street (retail) and investment (casino) functions of a
bank's activity and these requirements are expected to be fully implemented by 2019
(see
Vickers (2011) and
Chapter 14
for more details).
CO-ORDINATION OF FISCAL AND MONETARY POLICY
An important point to note at this juncture is that fiscal and monetary policies
are equally important in managing the macroeconomy. A change to either policy
has broad effects on many of the core macroeconomic objectives. Consequently,
all governments employ both fiscal and monetary instruments, although the
emphasis alters from government to government. Until 1997, the Chancellor of
the Exchequer directed the operation of both UK fiscal and monetary policy.
Although this theoretically meant that there could be a high degree of co-ordination
