Banks are the financial institutions that provide services of currency exchanging, deposits and other lending activities (Cecchetti & Schoenholtz, 2011). They are also responsible for portfolio management. In England, banks do not play a part in the determination of prices, this role lies on the Bank of England, which is the central bank in the United Kingdom. The Bank promotes growth and maintains economic stability. To retain price stability, the Bank ensures that increase in prices does not exceed the inflation mark set by the government. The Bank is also known as the lender of the last resort for banks, because, in its role of banking for commercial banks, it can give them credit if they have no other source to borrow from (Bank of England).
Money Supply Elasticity Policy
Commercial banks in the UK offer liabilities to public investors in terms of loans as a strategy to regulate economic activity. However, there are times when investors are not willing to acquire their loans because of personal reasons. In such cases, the Bank of England can come in and use a fiscal policy to alter the elasticity of the money supply. Controlling the money supply guarantees stability of prices, thus eliminating inflation and it also controls the interest and exchange rates. The Central Bank can control money supply in the three ways discussed in the three paragraphs that follow.
As a part of the reserve requirement, the BoE can expect all banks to keep a given amount of asset that bear no interest in it. The assets can be issued by the bank and have their nominal value accruing. This technique can help in the increase of deposit tax, which in turn would reduce the size of the banking sector. The long-term outcome would be an increase in the need for currency because the lesser the banks, the lesser the amount of money available for lending. The Central Bank would have the last word in such a strategy, and the outcomes would depend on the laid down rules. For example, if it makes the money in large supply , then the price level will continue to be determined by the real standard of the outstanding currency, which is an overall advantage to the economy (King and Plosser, 1984).
Moreover, it can make large controlled quantity the monetary base a large controlled quantity. It can then combine the minimum required reserve with another policy to make a hybrid. It can pick another policy, for example, the one that is controlling the total currency and the small bank reserves, and put them together to control the price level. Controlling the money regulates the price level equilibrium. When the price level equilibrium is controlled, it in turn controls the real deposits and real deposit services in the banks. The case assumes that the currency base is super-neutral, which means that it is not affected by other factors (King & Plosser, 1984).
Price level movements involve two factors. The first one is the impact of the circulation in the effect on the demand for currency from the public. The second is the result of the interest rates in the demand of outside currency. Unanticipated increases in wealth lead to high outputs and low rates of return. Therefore, wealth increments result in lower prices because the rates of returns are low, and the proceeds are high. The escalation of wealth also results in lower returns and higher yields in the future. Hence, the general effect on the price level is indefinite. A policy with a sensitive demand for interest can correct the prices and so can the program responding to the real movement. For example, generating outside money for output could bring out a positive connection between the output and the prices (King & Plosser, 1984).
Consistency of the Policy with the BoE
The strategies discussed above are in line with the practices of the BoE. For the Bank to maintain its financial stability, it should protect against pressures to the entire financial system including other banks. Any threats are spotted by the investigation and market intelligence appointed by the BoE.
Commercial banks are required to preserve a set amount of money known as reserve requirement with the Central Bank. When the backup money in the reserve bank is little, the banks have more money to lend thereby increasing the money supply in the economy. To decrease the money supply, the Bank of England (BoE) increases this reserve ratio. The BoE applies this method whenever it feels that the money in circulation is too much and is causing inflation (Fama, 1980).
The BoE also has control over the interest rates. A decreasing interest rates result in the decrease in the cost of money and increase in money supply. The interest rates are the rates at which it lends money to the banks that have failed to meet the agreed reserve ratio. If the rate is high, then the customers will limit the amount they borrow and vice versa. In the end, the money supply in the economy is controlled (Cecchetti and Schoenholtz, 2011). Fama (1980) says that the central bank can make currency rare quantity, and only supply it on demand by the commercial banks.
This essay has discussed the monetary base, which can be said to be the total money held by banks and the public. It has shown that the quantity is determined by the BoE, which has been given the mandate by the government. It has also seen that the ratio of the currency quantity in the economy and the high-powered money is strictly controlled by the same body. This ratio is controlled by the use of the money in circulation by both the banks and the public. For that reason, any change in the monetary base, or a shift in the ratio of the currency or even the reserve to deposit ratio affect the money supply. When any of these determinants changes, the BoE comes in to regulate and stabilize the economy. The BoE has been able to handle any financial issues that have come up over time, making sure that the UK economy is stable.
The commercial banks have also played an important role in ensuring that the policies of the Central Bank are adhered to. The banks have respected the directives that the Central Bank gives out when there is an economic crisis. However, following the Great Recession of the late 2000’s, the BoE needs to put more policies that will be able to handle monetary crisis in the future. This will protect the UK economy from unexpected changes in the value of the currency. The policies will also assist the commercial banks when investing in the public when they want to control economic activity. Therefore, in my opinion, these policies will take our economy to the next level.
Bank of England (n.d.). Web.
Cecchetti, S. G. & Schoenholtz. L. (2011). Money, Banking, and Financial Markets (3rd ed). New York: McGraw-Hill/Irwin.
Fama, E. F. (1980). Banking in the theory of finance. Journal of Monetary Economics, 6, 39-57.
King, R. G. & Plosser, C. I. (1984). Money, Credit, and Prices in a Real Business Cycle. American Economic Review, 74, 364-380.