monetary policy

• Monetary policy


  A set of macro policy actions undertaken by a country's central bank or monetary authority to control the supply of money and interest rates, to manage economic growth, control inflation, and ensure financial stability
• Responsibility for monetary policy

  Generally lies with a country's central bank or a similar regulatory authority
• Central banks responsible for monetary policy

  • Federal Reserve (US)
  • European Central Bank (Eurozone)
  • Bank of England (UK)
  • Bank of Japan (Japan)
  • Bank of Canada (Canada)
  • Reserve Bank of Australia (Australia)
• Bank of England (BoE)


  Central bank of the UK
• Objectives of the BoE

  • Financial system stability
  • Price stability
  • 2% inflation rate
• Primary objectives of the BoE

  Maintain price stability and financial system stability while supporting the overall economic policy of the government
• Price stability


  2% inflation target
• Banks' liquidity ratio


  The reserve account balances of commercial banks at BoE play a crucial role in meeting the objectives of the BoE
• Minimum reserve ratio


  A regulation that requires banks to hold a certain percentage of their deposit liabilities as reserves at the central bank
• Up until 1981, banks were required to maintain 12.5% of certain deposit liabilities as reserve at BoE
• In 1981 BoE removed its minimum reserve ratio requirement and currently there is no strict minimum reserve ratio requirement
• Reserve averaging


  Banks are required to hold an average amount of reserves over a maintenance period, which is typically one month
• Inflation targeting


  The core objective of the BoE's monetary policy—price stability— is primarily achieved by controlling inflation
• Since 1992, the government has set an explicit inflation target of 2% for the BoE
• 2% inflation target


  Seen as a balance between preventing harmful deflation and avoiding high inflation, which can distort economic decisions
• How BoE implements its monetary policy

  1. Government sets the inflation target

  2. Monetary policy committee (MPC) of the BoE chooses the rate of interest and other measures to ensure they achieve the 2% inflation target

  3. MPC meets formally eight times a year to decide on the appropriate monetary policy

  4. Decisions of the MPC are implemented through the BoE's operations in financial markets
• BoE operates a tight monetary policy or contractionary monetary policy

  To achieve the government's 2% inflation target
• Techniques to control the money supply

  1. Pay interest on all reserves banks maintain at BoE

  2. Use operational standing facilities - deposit and lending facility

  3. Use open market operations (OMO)

  4. Use quantitative tightening (QT) - outright sale of bonds
• Repurchase (repo) agreements


  The central bank typically uses repos to provide short-term funding to banks, ensuring that the interbank market functions smoothly and that the central bank's target interest rates are achieved
• Reverse repurchase (reverse repo) agreements


  The central bank sells securities to a financial institution with the promise to buy them back at a later date and at a higher price, allowing the central bank to absorb excess liquidity from the banking system
• Quantitative tightening (QT)


  The opposite of quantitative easing (QE), where the central bank sells financial assets back to the market to reduce the level of money supply in the economy and increase interest rates