Bank of England reaction for 2008 financial crisis Essay

Submitted By yangxiaomo
Words: 2107
Pages: 9

Introduction
In this essay, it will talk about how the Bank of England behave after the financial crisis of 2008, and how the macroeconomic change in the United Kingdom due to these behaviors. First, it will introduce the background and simply describe the financial crisis of 2008. Then, this essay will present the Bank of England’s responses and the transmission mechanism of the policy. At last, three macroeconomics indicators including GDP, inflation rate and unemployment rate would be presented as evidence to explain the outcomes of the policies.

Financial crisis of 2008
The financial crisis of 2008 began in the US. Oil price rose sharply in 2007, which increased the fears of a trade recession. Then the high unemployment rate triggered the beginning of a sharp rise in mortgage defaults. Because of that, the banks became more and

more

worried

about

the

security

and

value

of their own

mortgage-securitized investments. The banks were reluctant to lend money to other financial intuitions, reduced the loan scale and increased the cost of borrowing sharply, leading to a big liquidity problem which was fetal. Finally the global economy is falling in recession as a domino effect.

In the UK, businesses met the big fall of retail sales and unemployment rate kept rising. In face of the big crash, the Bank of England made changes in the monetary policy. The Bank of England’s objective is to keep the price stability, which is defined

by the inflation target. And the target inflation rate in UK is 2%. Here, it will disc uss the changes of monetary policy and how the changes affect the macroeconomic.

Near-zero official bank interest rate
The first action of the Bank of England ’s Monetary Policy Committee (MPC) is that they set a lower official bank rate. It is a usual monetary policy in UK. It operates through price at which money is lent-the interest rate. According to the website of the
Bank of England, the bank official rate was 5.00% in April 2008. The MPC first cut the interest rate to 4.50% in October 2008 after the bankruptcy of Lehman Brothers, which is the biggest bankruptcy ever. More cuts were made due to the worse and worse recession. Figure 1 show how the interest rate changes from April 2008 to
March 2009.The Bank of England eventually keep the rate at record low 0.50% from
March 2009 till now.
Figure 1 Interest Rate in the UK from 2008-2009

(Source: the Bank of England)
At normal time, the central bank always changes the short term interest rate by

purchasing the short-term government bonds to meet the target inflation rate. First, the official rate influences money markets like the retail loans, mortgage rates and retail savers. The loans lending rates usually would be adjusted by the commercial bank. So a lower official bank rate leads to a lower the cost of borrowing for firms thus stimulating spending. The lower interest rates means near zero return for both business and consumers, so that they would transfer the money from bank-account into market. They deposit less and spend more on investment and consumptions like housing and durable goods. The second one is bond prices. Because the bonds have a fixed price at maturity and a variable market price, there is an inverse relationship between the official interest rate and the price of bonds. A fall in interest rate would lead to a rise in bond price. Thirdly, the require rate of return in stock market would change as the interest change. RRR is usually calculated by compensation for the risk premium plus the risk free rate. Then if the risk free rate decrease, the required rate of return would decrease which cause a rise in stock price. The last one is the exchange rate. Decreasing in domestic interest rate leads to a depreciation of the domestic currency, which encourage the export of the whole country. For export firms, the depreciation of the sterling makes them much more competitive in the international market. At the same time, it makes the…