monetary policy webinar - amazon s3
TRANSCRIPT
What is Monetary Policy?
Monetary stability means stable prices and confidence in the currency. Stable prices are defined by the Government's inflation target, which the Bank seeks to meet through the decisions taken
by the Monetary Policy Committee (MPC).
The Bank of England has been independent of the UK government since May 1997
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Infla
tion rate
CPI inflation target = 2%
Inflation Rate in the UK Economy in Recent Years
A lower inflation rate means prices rise more slowly –this is known as disinflation
Source: Office for National Statistics
What is Monetary Policy?
Monetary policy involves changes in interest rates, the supply of money & credit and exchange rates to influence the economy
Market interest rates Bank Lending / Credit Supply to Private Sector
Currency markets e.g. external value of the £
Inflation targets e.g. 2% CPI target in the UK
Bank of England is the UK’s Central Bank
European Central Bank sets policy for Euro Zone
Examples of Interest Rates on Loans in the UK
There are thousands of different interest rates in the economy!
• Savings rates• Bank loans• Mortgages• Credit card rates• Payday loans• Corporate bonds• Government bonds
Latest UK interest rates• Base interest rate 0.5%• Two year fixed rate
mortgage 2%• £10k unsecured loan 5%• Savings deposit 1.5%
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Jan 2006
Sep 2006
May 2007
Jan 2008
Sep 2008
May 2009
Jan 2010
Sep 2010
May 2011
Jan 2012
Sep 2012
May 2013
Jan 2014
Sep 2014
May 2015
Jan 2016
Household deposit and lending interest rates
£10,000 unsecured loan
Two-‐year, fixed-‐rate mortgage, 90% loan to value
Two-‐year, fixed-‐rate mortgage, 75% loan to value
New fixed-‐rate time deposit
Base Interest Rates and Mortgage Rates in the UK
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2015
Effective mortgage interest rate Base rate
The policy interest rate (base rate) is set each month by the Monetary Policy Committee. The 2% inflation target is set by the government.
When the Bank’s interest rate changes, most other loan and savings interest rates in the financial markets will also change too . The Bank of England has left the Base Interest Rate in the UK unchanged at 0.5% since March 2009 – the lowest since the Bank was founded in 1694
Base Interest Rates and Mortgage Rates in the UK
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Effective mortgage interest rate Base rate
The policy interest rate (base rate) is set each month by the Monetary Policy Committee. The 2% inflation target is set by the government.
“Even when the economy has returned to normal levels of capacity and inflation is close to the target, the appropriate level of Bank Rate is likely to be materially below the 5% level set on average by the Committee prior to the financial crisis” (BoE)
Expansionary and Deflationary Monetary Policy
Expansionary Monetary Policy
Fall in nominal and real level of interest rates
Measures to expand the supply of credit from the
banking system
Depreciation of the external value of the
exchange rate
Deflationary Monetary Policy
Higher interest rates on both loans and savings
Tightening of credit supply (i.e. loans become harder
to get)
Appreciation of the exchange rate
Distinction between Nominal and Real Interest Rates
• The real rate of interest is important to businesses and consumers when making spending and saving decisions
• The real rate of return on savings is the money rate of interest minus the rate of inflation.
• So if a saver is receiving a money rate of interest of 6% but price inflation is running at 3% per year, the real rate of return on these savings is only + 3%.
• Real interest rates become negative when the nominal rate of interest is less than inflation
• For example if inflation is 5% and nominal interest rates are 4%, the real cost of borrowing money is negative at -‐1%.
• Price deflation can lead to an increase in real interest rates
Global Real Interest Rates
Factors Considered When Setting Policy Interest Rates
The BoE sets policy interest rates consistent with the need to meet an inflation target of consumer price inflation of 2%
1. GDP growth and spare capacity / estimates of output gap2. Bank lending, consumer credit figures, retail sales data3. Equity markets (share prices) and trends in house prices4. Consumer confidence and business confidence / sentiment5. Growth of wages, average earnings, labour productivity and
unit labour costs, surveys on labour shortages6. Unemployment and employment data, unfilled vacancies7. Trends in global foreign exchange markets (i.e. is sterling
appreciating or depreciation against other currencies)8. International data – e.g. GDP growth rates in economies of
major trading partners such as USA and Euro Area
UK Real GDP Growth Fan Chart
The Monetary Policy Committee considers forecasts for the rate of short-‐run economic growth – does it threaten rising inflation?
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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Perc
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ge c
hang
e on
a y
ear e
arlie
r
Source: ONS, OBR
Projected Inflation for the UK Economy
UK CPI inflation projection based on market interest rate expectations and £375 billion purchased assets (QE) – May 2016
For the last two years, CPI inflation has been well below the 2% target. Inflation forecast to rise back towards 2% from 2017 onwards –deflationary risks are receding.
The UK Wage Phillips Curve
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2001 Q1
2001 Q3
2002 Q1
2002 Q3
2003 Q1
2003 Q3
2004 Q1
2004 Q3
2005 Q1
2005 Q3
2006 Q1
2006 Q3
2007 Q1
2007 Q3
2008 Q1
2008 Q3
2009 Q1
2009 Q3
2010 Q1
2010 Q3
2011 Q1
2011 Q3
2012 Q1
2012 Q3
2013 Q1
2013 Q3
2014 Q1
2014 Q3
2015 Q1
2015 Q3
2016 Q1(a)
Unemployment Rate and Annual % Change in Regular Pay
Unemployment rate Regular pay growth
Annual Change in UK House Prices
-‐15
-‐10
-‐5
0
5
10
15
20
2004 Ja
n2004 Ju
n2004 Nov
2005 Apr
2005 Sep
2006 Feb
2006 Ju
l2006 Dec
2007 M
ay2007 Oct
2008 M
ar2008 Aug
2009 Ja
n2009 Ju
n2009 Nov
2010 Apr
2010 Sep
2011 Feb
2011 Ju
l2011 Dec
2012 M
ay2012 Oct
2013 M
ar2013 Aug
2014 Ja
n2014 Ju
n2014 Nov
2015 Apr
2015 Sep
2016 Feb
12 month percentage change in average UK house prices
House prices falling
A Falling Exchange Rate Raises Import Prices
-‐10
-‐5
0
5
10
15
2010 Ja
nuary
2010 April
2010 Ju
ly2010 October
2011 Ja
nuary
2011 April
2011 Ju
ly2011 October
2012 Ja
nuary
2012 April
2012 Ju
ly2012 October
2013 Ja
nuary
2013 April
2013 Ju
ly2013 October
2014 Ja
nuary
2014 April
2014 Ju
ly2014 October
2015 Ja
nuary
2015 April
2015 Ju
ly2015 October
2016 Ja
nuary
Sterling Exchange Rate Index and Annual Change in UK Import Prices% change on same month previous year, UK, January 2010 to March 2016
Trade weighted exchange rate Import prices
Estimated Size of the Output Gap
-‐5.0
-‐4.0
-‐3.0
-‐2.0
-‐1.0
0.0
1.0
2.0
3.0
2003 Q3
2004 Q3
2005 Q3
2006 Q3
2007 Q3
2008 Q3
2009 Q3
2010 Q3
2011 Q3
2012 Q3
2013 Q3
2014 Q3
2015 Q3
2016
Output Gap (Actual – Potential GDP, measured as % of potential GDP
Actual and Potential GDP for the UK Economy
95.0
100.0
105.0
110.0
115.0
120.0
125.0
130.0
2003 Q3
2004 Q3
2005 Q3
2006 Q3
2007 Q3
2008 Q3
2009 Q3
2010 Q3
2011 Q3
2012 Q3
2013 Q3
2014 Q3
2015 Q3
2016
Actual (non-‐oil) GDP and estimated Potential GDP for the UK, Index: 2003=100, Source: ONS and OBR, March 2016
Output (non-‐oil GVA) Potential output
Recent Changes in Global Oil Prices
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Global oil price $ per barrel
Transmission Mechanism of Monetary Policy
1 / Change in market interest rates
2/ Impact on aggregate demand
3/ Effect on output, jobs & investment
4/ Real GDP and the rate of Price Inflation
Normally a change in policy interest rates feeds through to borrowing/saving rates
Effect on spending, saving, investment and exports
Is there an expansion of production and employment?
Rate changes then affect two of the key macro objectives
It can take between 12-‐24 months for the full effects on real GDP and the inflation rate after a change in policy interest rates
When Interest Rates Fall
Cost of servicing loans / debt is reduced – boosting spending power
Consumer confidence should increase leading to more spending
Effective disposable income rises – lower mortgage costs
Business investment should be boosted e.g. Prospect of rising demand
Housing market effects – more demand and higher property prices
Exchange rate and exports – cheaper currency will increase exports
A reduction in interest rates or an increase in the supply of money and credit is an expansionary or reflationarymonetary policy
An expansionary monetary policy is designed to boost consumer confidence and demand during a downturn / recession
Evaluation: Why Low Interest Rates can be Ineffective
When consumer & business confidence (animal spirits) is low
When savers suffer a fall in their real incomes / purchasing power
When there is a very high level of unpaid debt
When there is deflation causing real interest rates to rise
When export markets are weak when a currency depreciates
When fiscal policy working in the opposite direction e.g. austerity
When low interest rates distort pension funds and create asset bubbles
The Keynesian Liquidity Trap
A liquidity trap occurs when low interest rates and a high amount of cash balances in the economy fail to stimulate aggregate demand
• In normal circumstances it is possible to boost demand by cutting interest rates. But for most countries there is a zero floor for nominal interest rates
• Even if interest rates can be lowered this may have little effect if people cannot or will not borrow. This is known as the liquidity trap.
• At this point, AD can only be boosted by the Government borrowing more, either to spend directly or to give to others via tax cuts
• Keynesians believe that size of the fiscal multiplier effect is higher for government spending than it is for tax cuts
• When private sector demand for goods and services is persistently low, the government needs to find a compensating source of demand to rebalance the economy – and the solution comes from the government in the form of higher borrowing or less saving.
Interest Rates and the Distribution of Income
Incomes of savers• If the interest on savings is less than inflation, savers will see a reduction in their real incomes
Incomes of home-‐owners with mortgages• If interest rates fall, the income of home-‐owners who have variable-‐rate mortgages will increase
Interest rates on unsecured debt• Lower interest rates on loans such as credit cards and bank loans will fall
When interest rates fall, there is a re-‐distribution of income away from lenders and savers towards borrowers with loans / debt
Quantitative Easing (QE)
• When policy interest rates are at zero or close to zero, there is a limit to what conventional use of monetary policy can do
• In March 2009 the BoE started quantitative easing for first time.
• The main aim of QE is to support aggregate demand and avoid the risk of a recession becoming a deflationary depression
• The Bank of England uses QE to increase the base supply of money in the banking system and encourage banks to lend at cheaper interest rates i.e. to small & medium sized businesses
• The Bank does not print new £10, £20 and £50 notes, it uses money created by the central bank to buy government bonds
• There are doubts about the effectiveness of quantitative easing –bank lending has struggled to recover since the end of the last recession. In the summer of 2015, QE in the UK totalled £375bn
How Quantitative Easing (QE) is meant to work
The central bank creates new money electronically by adding money to their balance sheet
This money is then used to buy financial assets -‐Mainly the purchase of government bonds
More demand leads to higher prices for assets e.g. bond prices. Rise in price of bonds leads to a lower yield (%) on government bonds
The effect of QE can feed through to a fall in long term interest rates e.g. mortgages and corporate bonds
Lower interest rates and increased cash in the banking system should then stimulate AD through a rise in consumption and investment
Key Challenges Facing the Bank of England
Maintainingprice stability i.e. avoiding deflation / accelerating inflation rates
Supporting a sustainable / durable
recovery – a return to “normal
conditions”
Helping to re-‐balance the economy towards
exports (X) and capital
investment (I)
Financial stability –building a
more secure banking /
credit system for the future
Has the Bank of England’s Monetary Policy helped?
Case for the Bank of England
Avoided a damaging depression after the worst of the 2008 crisis
Avoided sustained deflation + faster growth than many EU nations
More competitive currency has helped export sector to recover
Haven’t raised interest rates too early – responding to Euro Crisis
Criticisms of the Bank’s policyInflation allowed to rise well above
target in 2008 and 2012
Growing signs of another unsustainable housing boom
Low interest rates have become less effective e.g. in stimulating
investment
Britain has record current account deficit – symptom of wider
structural problems
Base Interest Rates and Mortgage Rates in the UK
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Effective mortgage interest rate Base rate
The policy interest rate (base rate) is set each month by the Monetary Policy Committee. The 2% inflation target is set by the government.
When the Bank’s interest rate changes, most other loan and savings interest rates in the financial markets will also change too . The Bank of England has left the Base Interest Rate in the UK unchanged at 0.5% since March 2009 – the lowest since the Bank was founded in 1694
What might happen if UK interest rates rise again?
MPC raises base interest rates
This signals a tighter monetary policy
Market interest rates increase (over
time)
Cost of borrowing rises
Main effect will be through via
mortgage rates
Causes a possible slowdown in
housing market
And a contraction in the growth of retail
credit
Higher rates might also cause a currency
appreciation
This makes UK exports more expensive in
overseas markets
Forward Guidance when setting interest rates
• Forward Guidance was introduced by Mark Carney in August 2013
• It has been signalled that the Bank of England will leave their policy interest rates unchanged as long as the unemployment rate is above 7.0% and inflation is under control
• The main aim is to build confidence by signalling that interest rates would stay at low levels for some time
• In 2014, Mark Carney signalled that forward guidance would evolve – LFS unemployment is not the sole data measure to be used – they will look at a range of measures of spare capacity
Evaluation Points on Interest Rates & Monetary Policy
• Time lags should be considered when analyzing effects of interest rate changes
• Monetary policy is not an exact science –consumers and businesses don’t always behave in a standard textbook way!
• Many factors affect costs and prices which can change the inflation risks in a country
• Monetary policy does not work in isolation! Consider how fiscal policy can also affect aggregate demand, output, jobs & prices
• Objectives of monetary policy can change –e.g. the USA Federal Reserve’s mandate is “maximum employment, stable prices, and moderate long-‐term interest rates”
