Financial Stability and Monetary Stability
In accordance with BIS [2003, p.3] financial stability can also be used to mean price stability. Simply put, price stability is a situation where prices do not change in an economy or the low levels of price increases in an economy before the stability process of an individual. Price inflation plays a major role when it comes to economic adjustment and an administrative role in the economy by the involved personnel. Price rises mainly warns the market of impending changes. The theory of financial stability [prices stability] is accepted and clear to many people. In contrast, the way we define monetary stability can vary with system approach and the unpredictable monetary changes that are easy to note. In relation to Mishkin [1991, p 79] prices stability is the dominance of a monetary system that offers a lasting solution without any complications and a proficient way to make savings. The level of monetary weakness is portrayed as the possibility; of the economy from going beyond the cut-off point and affects the distribution of savings.
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The Central Bank ensures that, there is a better economic stability, by making sure that, prices are stable and there is good money control. Financial policy governments or systems usually use interest rates as a tool to target low inflation that is also steady. With many changes in the financial policy rate, financial stability may be affected in one way or another. Many communication departments in a number of central banks designate that, taking in financial steadiness has consequences for a handy financial policy. For instance, at the bank of England financial evaluations are part of the preparations leading to practical monetary policy. The Bank of England Financial Stability mainly contributes to evaluation and collection of essential information from a number of financial quarters in addition to information linked to the financial status of organizations. Additionally, it offers specific references on the financial policy plan clearly on the financial steadiness position, whereby the macro-economic changes that are essential to financial stability are highly regarded when it comes to assessment. It is for this reason that, the financial policy should work effectively as it can to achieve the best path that can help maintain the best living standards of the society ensuring that there is a low and steady rate of price increases which is mainly the key means of financial policy to satisfy this goal [ BIS, 200, p.8].
Quantitative Easing and Its Effects
Central banks, like the bank of England and the Federal Reserve in the US, usually exercise great economic power by mainly setting important short- interest rates that influence the price of loans for the business sector. These central banks usually favor lower interest rates because they encourage lending, economic expansion and spending: whereas higher interest rates limit lending reducing economic development and inflation. In relation to the bank of England [n.d, p.3] the world economy is showing an explosive growth. Nevertheless, the interest rates at the Bank of England are at a lower level of 2 % and nearing the zero mark, hence making any imperative cuts is not workable. With these set conditions, the bank of England can easily try to encourage growth through quantitative easing, a tool that is increasingly becoming popular.
As depicted by Oda & Kunio (2001, p. 336), quantitative easing is a situation whereby the bank of England usually translates overnight funds into treasuries, influencing the privately owned sectors to use their savings and increase their cash. This is simply a major version of coupons that the bank needs to use. Quantitative easing also forces individuals out of reserves and engage them in transaction that increase their cash instead of savings. The central bank is not supposed to make more money available, but it usually swaps assets for privately owned sectors. Interestingly, Schwartz (1995, p. 22) clarifies that, the bank usually trades deposits with property that bear interest with private sector. A great process that can sometimes be called asset swap.
According to Nikolov et al. (2009, p. 49), the bank of England can easily reduce the interest rates by using purchases of assets that create high demand for debts whilst improving the bank balance sheet. Because of the lower interest rates, the bank of England mainly uses quantitative easing as an exceptional way of bringing in more money into the economy and ensuring long-term interest rates are low via purchase of many assets that are seized by financial institutions. For example, the bank of England [the UK central bank] engaged in quantitative easing in March 2009, where it bought U.K government bonds plus the debts issued by the private organizations. Through such undertakings, firms had a ton of money at hand, making money lending much easier.
The rates on long-term bonds may be lowered through quantitative easing. This is possible as the bank of England can take bonds out of distribution by mainly undertaking a large quantitative easing measure that will help purchase more long-term treasury bonds. Taking bonds out of circulation is an undertaking that may lead to increased demand for the bonds left in the competitive market. Hence, increasing their cost and lowering the yields [the cost of bonds and the yields is relatively opposite to each other] as issuers of bonds do not have to guarantee higher returns in order to attract more potential buyers. The lower rates should thus make investment that is more liable in the venture [Takeshi, K & Small, D 2004, p.9].
On the other hand, economist posit that, long-term bond rates may be low for a long duration, not because of the effects of quantitative easing on supply and demand of bonds, but because the bank of England uses easing as a way to be clear with the monetary policies in use. The bank of England needs to embark on a great intervention in order to affect the interest rates significantly. In accordance to European Central Bank [2003,p. 85], if the interest rates are affected immensely, then it is not the effect of direct ‘quantitative’ intervention, but because of the signaling that the bank of England will do anything to ensure that the interest rates are low as the financial system struggles with the recession. In contrast, quantitative easing should help theoretically to create great inflationary forces [as the bank of England is busy printing more money to buy assets]. Nevertheless, inflation has been low and dropped tremendously since March 2009 thanks to the quantitative easing struggles in Britain. This undertaking fulfilled the main aim of quantitative easing, which is chiefly to reduce the pressure on monetary institutions that offered loans to potential clients. Credit markets can be termed as the most innovative economic systems and so, they need to be open and liquid enough for effective economic operations.
The bank of England as used quantitative easing in the most effective way. It introduced quantitative easing to make market money operations effective. The overnight call rate at the bank was at the zero mark and so, it needed to come up with pushy and effective deflationary forces. Several components of quantitative easing were used in the application. The overnight rate at the bank was low and its target was the commercial bank’s outstanding balance of its current account. It got started by raising the current account balances and then raised the target levels. The bank of England then moved its asset purchases from the government short-term debt to long-term. This shift was alleged to bring out or to heighten portfolio-rebalancing impacts. It went further and made purchases of long-term bonds [Takeshi & Small, 2004 p.7].
Through quantitative easing, the financial base increased by the end of the year and the share of outstanding amount of long-term bonds [assets] increased. These effects made it easy for the bank to continue using quantitative easing using more advanced and modern techniques. By using quantitative effect, the bank was likely to have three main effects. It was to reduce the long-term interest rates, whilst it stabilizes the consumer prices index, it was to increase the buoyancy of investors in the UK sterling pound and to change the relative supplies of assets that were held by the public and so, be able to lead to changes in the relative cost of assets. Through these effects, there would be increased investment in the country, reduced unemployment and revivify the growth.
Problems and Potential Risks of Using Quantitative Easing
From the abovementioned discussion, the main idea for quantitative easing is to reduce or alleviate the pressure on financial institutions that loan clients and open up credit markets. Our modern economic system is supported by credit markets, and thereby, they need to be open and liquid enough to allow effective economic operations. Although, with the positive effects of quantitative easing, this efficient monetary policy tool as certain transitory and long-lasting impacts. When it comes to short-term effects, quantitative easing is primarily expected to reduce credit markets and encourage economic growth. This is an imperative effect has it keeps at bay any impending recession. If it is effectively used, this method can lead to important improvements of the UK sterling pound, therefore uniting investors to invest in UK. Ugai [2006, p. 90] posits that; the gathering would not be due to an actual approval of the UK pound but, it would be a getaway to quality progress. A large number of investors may view prospect and further decisions by the central bank on quantitative easing as a warning of very poor financial system that could cause them to look for help in the UK sterling pound.
The short-term effects of quantitative easing can be direct or indirect. According to Takeshi & Small [2004, p. 10], the direct effect of quantitative easing is one that is faced by those who issue bonds that have been bought and face lower yields and are tending to issue more [ More Treasury issuance]. This is blurred and twisty way of monetizing the government debts. Many times, the government wants a confined, non-economic buyer of its securities, and it has to take a period severe shortfall payments. The indirect effect of quantitative easing is that as the treasury yields fall, the yields on any other debts fall to a smaller level. A large number of investors in the market need yields, and as the safe yields drop, they go through many pressures in order to get the preferred income. The simple mystery of quantitative easing is that investors are in a dilemma of getting income and losing resources by mainly attracting great deal of threats. As per Takeshi & Small [2004, ps. 12], this conundrum explains the low stock assessment as quality bonds have higher yields. The yields obtained from high-quality bonds affected by quantitative easing mainly do not designate the true risks faced when lending these bonds. Nevertheless, quantitative easing affects stocks and lower quality bonds to an even lower level because; it is not easy to yield out quality instruments and large numbers of them will plunge into lower quality instruments.
When it comes to the long-term effects of quantitative easing, they can be examined mainly after understanding that, quantitative easing has never been executed by a developed nation as quick as it has been in US. In this view, the long-term impacts of quantitative easing have not been clear especially when it comes to economy. Conversely, there have been assumptions that quantitative easing could have effects on the economy in the long-standing. Oda & Kunio [2001, p. 345] argue that, the most vital threat of quantitative easing is price increases. For instance, in the United States, the Fed is introducing substantial supply of the U.S dollar into its economy so that it can easily lessen the recession and fuel the growth of economy. However, many economists argue that, quantitative easing will lead to inflation. Whilst economists predict prices increases, nothing has been reported in U.S where quantitative easing the in-thing and has been in use for a long duration. Actually, deflation has been widely reported than inflation. However, Ugai [2006, p. 106] argues that inflation can still be termed as the long-term effect of quantitative easing.
To experience economic growth, there must be more investments. However, the long-term exercising of quantitative easing can lead to loss of investor confidence mainly on the currency on use within the country. For example, the U.S government is the most trusted today, this makes it easy to finance the incentive debts persistently. Nevertheless, as quantitative easing continues to the best way to increase investment in the economy, many investors may lack self-assurance and trust more in the U.S dollar. Takeshi & Small  puts forward that, quantitative easing could weaken the investor’s trust in the currency of a country, an action that could lead to great problems in the financial system.
Prices steadiness can also refer to financial stability. Financial stability is the price level steadiness in the economy that also results to low levels of price increases. Stability of prices in an economy will in most cases influence the economy. Therefore, financial stability can spur the growth of the economy. Monetary stability is the ability of the economy to provide a country without any troubles to the well-organized distribution of savings in a financial system. Simply put, it can be the ability of the financial system to be easily broken and allow able performance of the economy. The central bank is usually in-charge of ensuring that there is economic stability that mainly triumphs via financial and monetary steadiness. These two terms relate with each other and they are very substantial for utilizing the financial and economic policies of the central bank. The central bank should thus, make use of a long-standing perspective than a transitory horizon because if it uses a medium-term horizon to maintain financial stability and involve a strategy encircling stability-oriented approach, monetary imbalance, it will utterly get the interest it deserves.
Quantitative easing is the main financial tool used by central banks to execute the financial policy goals and missions. Quantitative easing is used mostly when the central bank wants to spur the financial system and increase the economic activity and the interest rates are very low. The whole process involves the central bank taking on asset exchange with the privately owned sectors. The central bank primarily selects and purchases long-term bonds with higher yields from the public improving the money supply in the financial system without any uncalled for printing of more money. Quantitative easing has been implemented in a number of countries and it has proven to be effective. Currently, it is in use in U.S majorly to aid the U.S government to pull through from the effects of worldwide recession. In spite of the noticeable success it has brought, there are certain effects of quantitative easing and they include lack of confidence in the UK sterling pound an effect that has lead to reduced investments in UK economy and prices increases. It is for these reasons that, caution is essential even with its implementation and use.
Bank of England, n.d., Quantitative Easing Explained, retrieved on October 5, 2010 from: http://www.bankofengland.co.uk/monetarypolicy/pdf/qe-pamphlet.pdf
BIS, 2003, Monetary stability, financial stability and the business cycle: five views, BIS papers No 18. Retrieved on October 5, 2010 from: http://www.bis.org/publ/bppdf/bispap18.pdf?frames=0
European Central Bank, 2003, “The outcome of the ECB’s evaluation of its monetary policy strategy”, Monthly Bulletin, June, pp. 79-92.