Monetary policy is an action taken by a country’s central bank or government to impact the amount of money in the economy and the cost of borrowing. Inflation rates in a country are affected by monetary policy. The bank is the issuer of banknotes and, as the single supply of the monetary base, has the potential to influence price stability. Our primary focus is on how the Bank of England and the European Central Bank’s monetary policies influence the inflation rate. Interest rates in the UK economy are influenced by two primary tools, including the interest rates that banks are charged to borrow from them (Hix, S., Hyland, B., & Vivyan, N. 2010 p. 740). The second strategy is bond buying to decrease interest rates on savings and loans through quantitative easing, which keeps inflation low and steady. Every country has an inflation target; therefore, it brings a key change in the country’s interest rate in the bank rate. The bank rate is the discount rate a country sets when giving loans to commercial banks through a bill of exchange.
Central banks use three main monetary policy tools for price stability, and the Bank of England and the European Central Bank are examples of such banks. The first tool is the open market operation, whereby it may influence the money supply directly through the sale and purchases of securities in the stock exchange. During inflation, the central bank’s role is to ensure that credit and money supply is minimized (Gabor, D. 2021). When a country needs to increase credit volume, it purchases securities from commercial banks, paid through cheques.
The other monetary policy instrument is a change in reserve ratio, in which the central bank raises the reserve ratio requirement when it wishes to limit the money supply. When the money supply is increased, the reserve ratio need is reduced. The third strategy is credit rationing, in which the central bank determines the credit worthiness of each commercial bank and refuses to extend more credit over the limit set.
The European Central Bank uses three monetary policy tools to influence interest rates: open market operations, standing facilities, and holding low reserves. Open market operations are critical in directing interest rates, managing market liquidity, and expressing the desired inflation rate. Regular open market operations in the Euro system comprise one-week central bank operations in euro main refinancing operations (MROs) and three-month central bank operations in euro longer-term refinancing operations (LTROs) (LTROs). The Main Refinancing Operations are designed to regulate short-term interest rates, control liquidity, and signal the Eurozone’s monetary policy position. Long-term Refinancing Operations, on the other hand, give extra, longer-term capital to the banking industry.
Member-state credit institutions must maintain minimum reserves with the European Central Bank and national central banks. Minimum reserves attempt to stabilize market short-term interest rates while creating a structural liquidity shortfall in the banking system, which is the reverse of what happens in the Eurozone (Chugunov et al,. 2021 p. 42). This makes it simpler to regulate money market rates through regular cash allocations.
The target inflation of both Bank of England and the European Central Bank is 2 %. Therefore they both have to take action to stabilize the high inflation experienced in an economy.
A good and healthy economy has a low and stable inflation rate. With the high inflation rates, the Bank of England and the European Central Bank have to take up techniques that bring the economy to its inflation target (Williamson, S. D. 2021). The main way the Bank of England uses is through the interest rates being raised. The interest rates are the amount one gets on any savings they have and the charge one has to pay on their loans (Bilbiie, F. O., & Ragot, X. 2021 p. 80). Increasing the interest rates means that the amount one is required to pay for taking a loan is higher, and at the same time, the amount one gets from their savings is increased. This, in turn, encourages people to save instead of taking loans that pay so much money together with the loan in the long run. From saving, individuals will reduce their spending, and less spending causes the prices to rise slowly hence lowering the rate of inflation.
On the other hand, the European Central Bank uses the same technique to respond to the current high inflation caused by the energy costs, which has risen drastically. The interest rates have been increased, making loans more expensive. This forces individuals or businesses not to borrow the loans, slowing the rate of price changes in the economy.
References
Bilbiie, F. O., & Ragot, X. (2021). Optimal monetary policy and liquidity with heterogeneous households. Review of Economic Dynamics, 41, 71-95. https://www.sciencedirect.com/science/article/pii/S109420252030096X
Chugunov, I., Pasichnyi, M., Koroviy, V., Kaneva, T., & Nikitishin, A. (2021). Fiscal and Monetary Policy of Economic Development. European Journal of Sustainable Development, 10(1), 42-42. http://ojs.ecsdev.org/index.php/ejsd/article/view/1153
Gabor, D. (2021). Revolution without revolutionaries: Interrogating the return of monetary financing. Transformative Responses to the Crisis. Berlin: Finanzwende and Heinrich Böll Stiftung. http://tankona.free.fr/gabor121.pdf
Hix, S., Høyland, B., & Vivyan, N. (2010). From doves to hawks: A spatial analysis of voting in the Monetary Policy Committee of the Bank of England. European Journal of Political Research, 49(6), 731-758. https://www.sciencedirect.com/science/article/pii/S0261560621002308
Williamson, S. D. (2021). Central bank digital currency and flight to safety. Journal of Economic Dynamics and Control, 104146. https://www.sciencedirect.com/science/article/pii/S0165188921000816
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