What is inflation?

Why is high inflation bad?

Why is deflation bad?

Monetary Policy

Monetary Policy is primarily about controlling inflation…

According to the Bank of England: ‘the broad aim of monetary policy is to achieve price stability’

"For all practical purposes, price stability means that expected changes in the average price level are small enough and gradual enough that they do not materially enter business and household decisions.”(Alan Greenspan, former Chairman, US Federal Reserve)

Monetary Policy

But be aware that it can also be used to boost or dampen economic demand!

Monetary policy is conducted in two main ways:

1.) changing interest rate

2.) changing money supply

Monetary Policy

Changing the interest rate

The INTEREST RATE is used to influence AGGREGATE DEMAND

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I:

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Monetary Policy

Changing the interest rate

In 1997 Bank of England made independent from the government and given responsibility for monetary policy

- Target = 2% Consumer Price Index (CPI)

- Achieved through changing base rate of interest

- Monetary Policy Committee meets monthly to vote on any interest rate changes

- It takes 18-24 months for interest rate changes to have their full effect on the economy

Monetary Policy

A change in the interest rate will affect pretty much everyone in the UK.

Monetary Policy

Monetary Policy1. How will an increase in the interest rate affect each of the following people/businesses:

2. What will happen to aggregate demand?

How do interest rate changes affect Aggregate Demand?...

The Transmission Mechanism

Monetary Policy

Monetary Policy

Activity

You are a member of the Monetary Policy Committee and you have to vote on whether to increase or reduce the interest rate in the following scenarios…

Monetary Policy

1.) Unemployment is falling and consumer spending is increasing, CPI is currently at 2.6% and rising

2.) GDP growth is negative and business confidence is low, CPI has recently dropped from 2.2% to 2% 3.) Inflation in the Eurozone is currently at 3%, house prices increased 15% last month, and real wages increased by 5%. CPI is currently on target at 2%

4.) Consumer confidence fell 10% last month and the price of oil fell by 20%. CPI recently dropped from 2.3% to 2.2%

Monetary Policy

Monetary PolicyChanging the money supply: Quantitative Easing

Check out the blog for a simple explanation...www.dbseconomics.blogspot.com

Monetary PolicyChanging the money supply: Quantitative Easing

Monetary Policy Effectiveness of Monetary Policy

Advantages Disadvantages

What’s Been Happening Recently?...

Monetary Policy

February 2011 Inflation Report

Chart 5.1 CPI inflation projection based on market interest rate expectations and £200 billion asset purchases

Charts 5.1 and 5.4 depict the probability of various outcomes for CPI inflation in the future. They have been conditioned on the assumption that the stock of purchased assets financed by the issuance of central bank reserves remains at £200 billion throughout the forecast period. If economic circumstances identical to today’s were to prevail on 100 occasions, the MPC’s best collective judgement is that inflation in any particular quarter would lie within the darkest central band on only 10 of those occasions. The fan charts are constructed so that outturns of inflation are also expected to lie within each pair of the lighter red areas on 10 occasions. In any particular quarter of the forecast period, inflation is therefore expected to lie somewhere within the fans on 90 out of 100 occasions. And on the remaining 10 out of 100 occasions inflation can fall anywhere outside the red area of the fan chart. Over the forecast period, this has been depicted by the light grey background. In any quarter of the forecast period, the probability mass in each pair of identically coloured bands sums to 10%. The distribution of that 10% between the bands below and above the central projection varies according to the skew at each quarter, with the distribution given by the ratio of the width of the bands below the central projection to the bands above it. In Charts 5.1 and 5.4, the ratios of the probabilities in the lower bands to those in the upper bands are approximately 4:6 at Years 2 and 3. The upward skew at Year 1 is smaller. See the box on pages 48–49 of the May 2002 Inflation Report for a fuller description of the fan chart and what it represents. The dashed lines are drawn at the respective two-year points.

Chart 5.7 GDP projection based on market interest rate expectations and £200 billion asset purchases

The fan chart depicts the probability of various outcomes for GDP growth. It has been conditioned on the assumption that the stock of purchased assets financed by the issuance of central bank reserves remains at £200 billion throughout the forecast period. To the left of the first vertical dashed line, the distribution reflects the likelihood of revisions to the data over the past; to the right, it reflects uncertainty over the evolution of GDP growth in the future. If economic circumstances identical to today’s were to prevail on 100 occasions, the MPC’s best collective judgement is that the mature estimate of GDP growth would lie within the darkest central band on only 10 of those occasions. The fan chart is constructed so that outturns are also expected to lie within each pair of the lighter green areas on 10 occasions. In any particular quarter of the forecast period, GDP is therefore expected to lie somewhere within the fan on 90 out of 100 occasions. And on the remaining 10 out of 100 occasions GDP growth can fall anywhere outside the green area of the fan chart. Over the forecast period, this has been depicted by the light grey background. In any quarter of the forecast period, the probability mass in each pair of identically coloured bands sums to 10%. The distribution of that 10% between the bands below and above the central projection varies according to the skew at each quarter, with the distribution given by the ratio of the width of the bands below the central projection to the bands above it. In Chart 5.7, the ratios of the probabilities in the lower bands to those in the upper bands are approximately 6:4 at Years 2 and 3; the downward skew is somewhat smaller at Year 1. See the box on page 39 of the November 2007 Inflation Report for a fuller description of the fan chart and what it represents. The second dashed line is drawn at the two-year point of the projection.

Chart 2.3 Public sector net borrowing(a)

Sources: HM Treasury, Office for Budget Responsibility (OBR), ONS and Bank calculations.

(a) Measures exclude the temporary effects of financial interventions. Observations to the right of the vertical line are projections.(b) Projections for public sector net borrowing come from the OBR’s November 2010 Economic and Fiscal Outlook. Data prior to 2009/10 are based on ONS data. (c) Public sector net borrowing minus net debt interest payments, adjusted for the effects of the economic cycle. Bank calculation based on the OBR’s November 2010 projections for the

primary deficit and its projection of the output gap from 2009/10. Estimates prior to 2009/10 based on ONS data and HM Treasury’s March Budget 2010 estimates of the output gap.

Chart 2.7 Household saving ratio(a)

(a) Percentage of household post-tax income (not adjusted to account for the impact of FISIM).(b) Recessions are defined as in Chart 2.5.

Chart 2.9 Indicators of service sector investment

Sources: BCC, CBI, CBI/PwC and ONS.

(a) Net percentage balances of companies that say they have revised up planned investment in plant and machinery over the next twelve months. Data cover the financial, retail and consumer/business services sectors and are weighted together using shares in real business investment.(b) Net percentage balances of companies that say they have increased planned investment in plant and machinery over the past three months. Data are non seasonally adjusted.

Chart 2.12 Euro-area GDP(a)

Sources: Eurostat and Bank calculations.

(a) Chained-volume measures.(b) Austria, Belgium, Cyprus, Finland, France, Italy, Luxembourg, Malta, Netherlands, Slovakia and Slovenia.

Chart 1.4 Selected European ten-year spot government bond yields(a)

Sources: Bloomberg and Bank calculations.

(a) Yields to maturity on ten-year benchmark government bonds.

Chart 1.7 International nominal effective exchange rates

Chart 1.14 Loans to individuals

Chart 2.14 UK imports and import-weighted demand(a)

(a) Chained-volume measures.(b) Excluding the estimated impact of MTIC fraud.(c) Scaled to match the mean and variance of imports since 1987. Calculated by weighting household consumption (including non-profit institutions serving households), whole-economy investment (excluding valuables), government spending, stockbuilding (excluding the alignment adjustment) and exports (excluding the estimated impact of MTIC fraud) by their respective import intensities. Import intensities are estimated using the United Kingdom Input-Output Analytical Tables, 1995.

Chart 3.9 Company liquidations in England and Wales and GDP

Sources: The Insolvency Service and ONS.

(a) Chained-volume measure at market prices.(b) Changes to legislation, data sources and methods of compilation mean the statistics should not be treated as a continuous and consistent time series. Since the Enterprise Act 2002, a

number of administrations have subsequently converted to creditors’ voluntary liquidations. These liquidations are excluded from both the headline figures published by The Insolvency Service and the chart.