Monetary Policy In The Post Crisis Period

Banking system is very complex system, which not everybody could understand. But when the person gets the hang of it, he understands how numbers and market can change the world for regular working people. There are different ways for the market to be manipulated for the good sake or the bad. Often government would move countries money for both good and bad sides, so there would be a balance in the economy. Today I am going to present some of the methods Central Banks uses to increase or decrease the economy.

Explain what is meant by the term “loosen monetary policy’” and distinguish between conventional and unconventional monetary policy. (500)

Loosen monetary policy means that money supply is expanded and is more easily available to the public to boost economic development. Central banks reduce the discount rates, provides banks with an encouragement to loan money. ‘With the implementation of loose monetary policy, small businesses benefit from expanded credit opportunities, leading to increased investment, production and employment options. ’ (Long, 2019) Loose monetary policy leads to inflation which weakens the productivity of the economy and influences economic development. Although, monetary policy that is too tight may produce deflation which results in decrease in production and rising unemployment. Therefore, getting monetary policy right is crucial for the overall health of the economy. There are conventional and unconventional monetary policies. One of monetary policy instruments is conventional instrument. The central bank impact interest rates by tightening or loosening monetary base. The central bank can do that using his main tools of monetary policy: Open market operations (OMO), Discount rates, Reserve requirements. Open market operations are an important tool for buying and selling treasury bills, company bonds or foreign currencies in return for cash on deposit at the central bank. ‘If the central bank wishes to lower interest rates (executing expansionary monetary policy), it purchases government debt, thereby increasing the amount of cash in circulation or crediting banks' reserve accounts. Commercial banks then have more money to lend, so they reduce lending rates, making loans less expensive. ’ (Wikipedia, 2019) Lower borrowing rates boost consumer spending. Companies trying to keep up with this consumer demand hire more worker, whose income increasing, which in its way also raises the demand. There is another monetary policy way, used more when interest rates are at near 0% and there are worries about deflation, called unconventional monetary policy. Unconventional policy uses these tools: asset purchases (quantitative easing), forward guidance, and liquidity provisions. ‘In credit easing, a central bank purchases private sector asset to improve liquidity and improve access to credit. ’ (Roubini, 2016) Quantitative easing encourages lending and investment. ‘Quantitative easing increases the money supply by purchasing assets with newly created bank reserves in order to provide banks with more liquidity. ’ (Chappelow, 2016) Besides two major monetary policy instruments ad their tools, there are other factors affecting the monetary base, which are out of control of the central bank. Two major factors include: Float and Treasury deposits at the central bank. Float is ‘… money within the banking system that is briefly counted twice due to time gaps in the registering of a deposit or withdrawal, usually due to the delay in processing paper checks. A bank credits a customer's account as soon as a check is deposited. ’ (Segal, 2019) It helps to brief net increase in the amount of reserves in the banking sector caused by national bank’s cheque clearing process. So, more developed countries try to bolster their economy using monetary policies, but different countries use different methods or strategies. As mentioned, before they have the power to manipulate market and interest rates, consumer demands and employability.

Compare and contrast UK, US and ECB quantitative easing policies and explain the role that differences in financial system structure may have played in influencing unconventional monetary policies in these jurisdictions. (1000 words)

Quantitative easing is trying to reduce interest rates to help stimulate growth in the economy, boost spending and investing. Primarily goal of central bank is ‘keeping inflation close to a target level (in most advanced economies set near a 2% annual rate) over the medium term, and in some cases also pursuing an employment objective. ’ (Potter, 2019) If inflation is too low, or negative, then individuals may put off spending because they think that costs should fall. ‘Although lower prices sounds like a good thing, if everybody reduced their spending then companies could fail and people might lose their jobs. ’ (Bankofengland. co. uk, 2019) Negative interest rates is one of unconventional monetary policy tools. The first negative interest tool was ‘deployed by Sweden's central bank in July 2009 when the bank cut its overnight deposit rate to -0. 25%. The European Central Bank (ECB) followed in June 2014 when it lowered its deposit rate to -0. 1%. ’ (Johnson, 2019) Negative borrowing rates are a radical method which shows that experts are afraid that Europe is at risk of plunging into a ‘Deflationary spiral. ’ (Kagan, 2018) Deflationary spiral is a reaction to falling prices, leading to falling production, then lower wages, decreased demand, bankruptcy and still holding lower prices. ‘When deflation occurs, central banks and monetary authorities can enact expansionary monetary policies to spur demand and economic growth. ’ (Kagan, 2018) Sometimes monetary policy fail, leading to weakening economy and a spiral amount of vicious chain of events. Present ECB deposit rate is ‘all-time low of -0. 5% in a bid to stimulate the flagging Eurozone economy. ’ (Togoh, 2019) European Central Bank will cut their rates as long as necessary and will resume buying Eurozone government bonds. This method ‘could encourage those governments to borrow more money to invest in national projects. ’ (Togoh, 2019) But bigger negative interest rates will cut significantly more into earnings of European banks. They have a solution to exempt some banks’ holdings. It is called two-tier system. ‘… two-tier system for reserve remuneration, which exempts part of credit institutions’ excess liquidity holdings (i. e. reserve holdings in excess of minimum reserve requirements) from negative remuneration at the rate applicable on the deposit facility. ’ (Ruhkamp, 2019) This method tries to sustain the level of inflation to the ECB’s aim. Also this decision intent to help the bank-based transmission of monetary policy, while protecting the effective input of negative rates to the accommodative position of monetary policy.

From great recession that happened in 2007 through December 2018, the US Federal Reserve took one of monetary policy tools - quantitative easing steps ‘… reducing the federal funds rate from 5. 25% to 0% to 0. 25%, where it stayed for seven years. ’ (Johnston, 2019) Also to cutting down the federal funds rate, the Fed also used open market operations (OMO). ‘Between 2008 and 2015, the US Federal Reserve in total bought bonds worth more than $3. 7 trillion. ’ (BBC News, 2019) This method helped to reduce rates across maturities. The federal funds percentage cut focused on short-term borrowing, but using OMO allowed the Fed to also decrease transitional and longer-term rates as well. Purchasing obligations in the open market boosts their cost and brings down the yield. Selling obligations diminishes the cost and increases the yield. This is how interest rates can be manipulated. Quantitative easing and Bank Reserve has requirements. ‘The Fed requires that banks hold around 10% of deposits either in cash in the banks' vaults or at the local Federal Reserve Bank. ’ (Amadeo, 2019) At the point when the Fed includes credit it gives the banks more than they need in funds. Banks then try to make a profit by loaning the surplus to different banks.

The main risk of pumping more money into the economy could lead to an inflation problem. But if interest rates are lowered close to zero there would be a problem that economy could fall into ‘Liquidity trap, where people are no longer incentivized to invest and instead hoard money, preventing a recovery from taking place. ’ (Hayes, 2019) Aside from decreasing borrowing price, specialists of negative rates say that they help weaken a country’s currency by making it a less attractive investment than other currencies. ‘A weaker currency gives a country’s export a competitive advantage and boosts inflation by pushing up import costs. ’ (Koranyi, 2019) Besides that, negative interest rates means that businesses and households get even cheaper loans. This is one of Trump's inspirations for craving negative rates on the dollar. Yet, negative rates also restrict the limit that financial institutions earn from loaning. If ultra-low rates stays to long then they can hurt the health of financial institutions too much, they could quit lending and harm the economy. When the global recession took place in 2008, the Bank of England quickly lowered interest Rate from 5% to 0. 5% to support the UK’s economic restoration and started to create new money pumping the financial system. ‘When the global recession took hold in late 2008, we quickly lowered Bank Rate from 5% to 0. 5% to support the UK’s economic recovery. ’ (BBC News, 2019) Among concern over the brexit process taking place and worries about productivity and economic rise. So, Europe has a problem with very low interest rate, they have spent over 2 trillion euros buying up mostly government, corporate debt, asset-backed securities. As wished, QE has raised economic growth, but inflation remains subdued. UK had great economy recovery, but they have a problem with their currency after quantitative easing.

In the context of the EU and the ECB, identify the weaknesses of quantitative easing policies and discuss why there would be opposition to a further loosening of monetary policy. [500 words]

Quantitative easing in the short term provide monetary stimulus and great results, but in the long run they create monetary instability. This method solves one problem but creates another as I mentioned in examples of EU or UK in precious question. The main problems that could occur is inflation low or negative interest rates, unemployment and depreciating exchange rate. ‘Quantitative easing has the potential to be inflationary because the created money could lead to a rise in the money supply which causes inflation’ (Pettinger, 2019) When the economy recovers in the future the expanded money supply may cause inflationary pressure. But in a liquidity trap, higher inflation may help the economy to recover. “From an economic point of view, the ECB has already entered the territory of monetary financing of government spending, which is strictly prohibited by the [Maastricht] Treaty. ” The former central bankers also warned that negative interest rates would “favour owners of real assets” and “create serious social tensions. ” (Arnold, 2019) Another weakness would be too low interest rates or negative interest rates. With low interest rates prices of lending going down. It is easier for businesses, they can lower the prices of goods. But with interest rates close to zero, demand also decreases leading to businesses firing employees. The economy is risking to fall into ‘The liquidity trap, where people are no longer incentivized to invest and instead hoard money, preventing a recovery from taking place. ’ (Hayes, 2019) As ECB wanted Quantitative easing has raised economic growth with wages and lending also rising but inflation remains restrained, complicating the Quantitative easing to exit. This ensures that interest rates will stay at record lows for some time. Under QE the ECB's balance sheet has expanded to about 4. 65 trillion euros.

Having hit a top of 80 billion euros every month in 2016, asset buys have gradually fallen ‘with monthly bond buys at 15 billion euros in the final quarter of 2018‘ (Carvalho, Ranasinghe, Wilkes, 2019) Eurozone reacted in the expected way. Long-term borrowing rates fell, equity prices increased and the euro decreased relative to the dollar. But past experience shows that these policies will not do a lot to increase price inflation in the Eurozone. To make real progress individual countries should depend less on quantitative easing by the European Central Bank and ‘target straight on structural reforms and fiscal stimulus’ (Feldstein, 2016)

National banks have put significant weight on communicating how they respond to changes in the economic attitude. Relying upon the private sector's comprehension of this reaction function, balanced even without explicit correspondence from the central bank about its future activities. Along these lines, a credible arrangement technique focusing on keeping inflation close to its objective level over the medium term helped to bring down private area inflation expectations, which in turn helped to balance out the economy. So the economy after the global recession restored significantly well, but there are still problems in the world of economy that need to be solved, because when you figure out one problem, other occurs.

References:

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List of Figures:

1. 1. Fingfx. thomsonreuters. com. (2019). [online] Available at: [Accessed 3 November 2019].