Running head: MONETARY AND FINANCIAL SYSTEM 1

Monetary and Financial System

Student’s Name

Institutional Affiliation
MONETARY AND FINANCIAL SYSTEM 2

BOE’s Commitment to Cut Interest Rates up Endurance of Economic Weakness

According to the Mark Carney, the Bank of England Governor, the central bank is likely

to reduce the rates of interest upon the persistence of the weakness in the economy. Carney’s

remarks drove the U.S. dollar to almost a couple of weeks high against sterling pound as he

hinted on Monetary Policy Committee Debate regarding possible reduction of interest rates. Two

policymakers, in the last two months of 2019 voted to have Bank of England’s interest rates

reduced from 0.75% to 0.5% (Strauss, 2020). However, Carney supported holding of the rates at

their former rate. Despite optimistic businesses and consumers, the economy of Britain remain

relaxed growing at feeblest year-round rate from 2012 to the date.

Investors honed on Carney’s remarks regarding probable reduction of rate, despite his

description for the optimism of the businesses and the consumers. Further, he connected rate

reduction with the outlook of the current economy of the country. On his speech on Bank of

England inflation targeting event, Carney said “With the relatively limited space to cut Bank

Rate, if evidence builds that the weakness in activity could persist, risk management

considerations would favor a relatively prompt response.” Similarly, Jonathan Haskel and

Michael Saunders used parallel language in previous MPC minutes who also backed reduction of

the rate. After combination of possible acquisition of assets and probable interest rate reduction,

the governor of BoE indicated the banks present armory equaled cutting the rate of the bank by

2.5%. Currently, the price of money market is coarsely 14% probable BoE interest rate

reduction. Carney, on acquisition of assets, hinted the possibility of doubling sixty billion pound

of Bank of England stimulus package of 2016, August. The sum was prospected to increase as a

result of additional issuance of government bonds in future.

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In the meantime, Carney pointed out why the Bank of England may not reduce its interest

rates, quoting stability of labor market in Britain and uncertain emblems of stabilizing global

economy. Additionally, he quoted indication that business uncertainty had reduced after Johnson

won 12 December election. He clearly indicated that inflation target increment, hypothetically

worked better than practically as it was viewed by the economists. Carney resisted view from

those who believed they should be addressing societal challenges such as environmental

spending and funding infrastructure due to their financial stability. He claimed that adoption of

higher inflation targets would adversely affect low income people.

Bank of England has played critical role in fighting future recession by subduing and

lowering the interest rates to ensure stability of the economy. However, Carney admitted the

central forecast of Bank of England is that slow-moving growth of UK economy was expected to

pick up 2020. During the third quarter of 2019, slow annual rate of 0.3% was witnessed which

marks gentlest rate since the beginning of the last century. Carney also admitted that new finance

development and sustainability will be influenced by credibility of climate policy and the

cohesion of the countries (Strauss, 2020). Finances are likely to amplify or rather complement

climate policies however, it cannot be seen as substitute to climatic policies.

Additionally, Mark Carney admitted that the economy of England is likely to be hit

hardly by the current corona virus epidemic. Carney anticipates possibilities of difficult

economic forecasts as well as cutting of interest rates which may adversely affect budgets in

some months to come. Addressing the Sky News on the last week of February, 2020, the BoE’s

governor, explained that the central bank had picked up UK companies signs and predicted

sluggish growth of the economy as a result of the virus. Carney noted insisted that “Things are

getting tight, hard to be precise about the magnitude and, very importantly, the duration” within
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which the virus could harm the economy of UK. Due to increased cases of the virus being

reported outside China geographical boundary, Carney noted that the despite less tourism, the

economy of United Kingdom could not be isolated from the effects of virus, as such, it is likely

to impact on UK activity as well.

In as much, the leaving chairman of BoE failed to mention how virus may affect

monetary policy, the odds increment of 0.25% point cut have been witnessed in the financial

markets. As a result of prospected threat of virus to the UK’s economy, the Bank of England

members of monetary policy committee may be unwilling to support any boosting of

expenditure. The deputy governor of the Bank of England indicated that they could hardly do

much on coronavirus by terming it as “pure supply of shock.” Other world central banks have,

however, adopted further nuanced perception towards the virus, claiming that the fear of the

virus will significantly reduce expenditure hence leading to demand shortfalls resulting from

supply problems. Taking all that in consideration, Carney suggested downgrading of the

economy forecasts in order to shape the budgets of the bank.

Importance of the Monetary and Financial System

The reaction of monetary and financial systems to any economic activity plays critical

role on behavior of economy. Monetary systems play an indispensable role in formulation of

interest rates as well as adjusting the levels of inflation in the country. Monetary systems boosts

or rather enhances the growth of economy by increasing availability and reducing the cost of

credit financing through control of balance of payment and inflation levels (Schinasi 2013, p.

76). Therefore, monetary systems principally controls inflation as well as credit besides ensuring

stability and consistency of the levels of the price. In this way, it ensures economy of the country
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is enhanced via achievement of balance of payment equilibrium or rather balance and stability of

the exchange rate.

In controlling the inflationary rates, monetary systems employs both use of qualitative

and quantitative measures to curb the inflation pressures emerging in the development process.

In addition to central bank control over instruments of monetary policy, banking institutions

keeps cash-deposit ratio which is elastic. Meanwhile, commercial banks maintain liquid form of

reserves such as cash, foreign exchange and gold. They resist government security investments

because of their low interest rate which may not be consistent which banks motive to makes as

much profit as possible.

Commercial banks hardly borrow funds from central banks as the rate of the bank are

fundamentally ineffective as a result of narrow bill market size, unavailability of discount bills,

extensive barter trade where large number of transactions are not monetized, extensive

disorganized money market, keeping large cash reserves by the numerous commercial banks.

The cash reserves kept by the commercial banks cannot be reduced by central bank through sale

pf securities or increasing the banks rate (Schinasi 2013, p. 76). However, liquidity of banks is

reduced by raising the ratio of cash reserves. In influencing the credit allocation, qualitative

measures of controlling credit are seen to be operative as compared to quantitative measures.

There is strong tendency of investing in real estate, jewelry and gold in developing countries

rather than investing in productive and dynamic changes which are available in industry,

plantation, mining and agriculture. This plays significant role in controlling and reducing

economy’s sectional inflations.

Monetary systems also help in achieving price stability within the economy. The

adjustments between supply and demand of money within an economy is brought about by
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monetary policy which leads to achievement of prices stability. It reflects the imbalance between

demand and supply of the money. As widely excessive supply of money in an economy results in

inflation whereas undersupply of money in an economy leads to retarded growth of economy.

With development of economy, the amount of money demanded heightens as a result

monetization of non-monetized sector as well as industrial and agricultural production increment.

As a result, speculative motives and demand for transaction will rise. In this case monetary

systems raises supply of money proportionally to the money demanded thus curbing inflationary

pressures.

Monetary systems help in bridging the balance of payment deficit through interest rate

policy. In the process of fulfilling their development targets, developing countries usually

develop serious difficulties in their balance of payments. In establishing fundamental

infrastructures including transport and power, underdeveloped countries usually import capital

items such as components, spares, raw materials, machinery and equipment, in this case they end

up importing more than they can normally export creating imbalance between the two. This gap

is however narrowed by the monetary institutions via charging supernormal interest rates. Thus

attracting foreign investment inflows which help to bridge the gap between import and exports.

Financial systems regulate interest rates to strengthen the economy of the country.

Through high interest policies, monetary systems encourage savings which heartens economy

monetization. Similarly, charging high interest rates also discourages inflations through

borrowing limitation besides disheartening the foreign currency investments (Nagy and Kiss

2016, p. 14). Through interest rate policy, scarce capital resources are allocated productively in

various sub-systems. From economists view point, low interest policy is more favorable in

comparison with high interest as it encourages investments. Monitory systems sometimes apply
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discriminatory rate of interest by charging low rates to productivities besides charging high rates

unproductive and non-essential activities.

The Roles and Functions of Financial Institutions

UK’s financial institutions consists of banking institutions, stock brokerage firms,

insurance firms, management firms and building societies. These financial institutions distributes

resources especially finances in productive manner to the consumers. Financial institutions

accepts deposits from customers, provide them with mortgage, commercial and real estate loans.

They also issue share certificates to the stockholders. Additionally, they help users with

monetary needs in accessing finances to them, in return they charge interest on the amount lend

to the consumers.

Financial institution play an indispensable role in managing and directing payment

systems which involve daily commercial transactions involving businesses as well as individuals.

It is the role of financial institutions to maintain the payment systems active via wire transfers,

credit cards, saving and checking account (Schinasi 2013, p. 76). The aforementioned channels

enable Englanders to complete their daily transaction transactions more easily and conveniently.

Additionally, financial institutions extend credit to the consumers with good credit rating thus

affording corporations as well as individuals with necessary resources to conduct their activities.

These corporations allow entities and individual to borrow money by pulling their resources

together which is rented and repaid back regularly by the consumers. Capital acquisition of

personal project, existing or new business may be challenging, as such these institutions affords

entities as well as other persons access to financial support needed to start or enhance their

businesses and other activities.

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Financial institutions collectively work together forming an interdependent financial

system thus increasing the stability of the economy. Working together of the financial

institutions reflect healthy functioning and stable monetary systems (Campiglio et al. 2018, p.

465). Arguably, the performance of any economy rests on vigorous financial institution

functioning. Financial institutions take part in maintaining stock market, bodies such as stock

exchanges and brokers enable the entities to issues stock on the market thus enabling prospective

investors to acquire or rather purchase the company shares. This enhances the cash-flows of the

offering company which in turn drives the pulse of whole financial system.

Risks and uncertainties are part of companies as well as individuals hence essential to

come up with strategies to handle them whenever they happen. Financial institutions especially

insurance provides cover to insulate the firms from suffering financial burden in case of

unforeseen uncertainties. These financial institutions enable individuals and entities to pool

together thus sharing risks (Nagy and Kiss 2016, p. 12). In this way, handling difficulties or

accidents become easier whenever they occur. Finally, financial institutions facilitate movement

of financial resources from one region to another. They aid in transferring huge amounts of

money such as purchase real estate, corporate investments, annuity payments, transferring

construction loans among others.

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Bibliography

Buiter, W.H., 2014. The role of central banks in financial stability: how has it changed?. The

Role of Central Banks in Financial Stability: How Has It Changed, pp.11-56.

Campiglio, E., Dafermos, Y., Monnin, P., Ryan-Collins, J., Schotten, G. and Tanaka, M., 2018.

Climate change challenges for central banks and financial regulators. Nature Climate

Change, 8(6), pp.462-468.

Nagy, Z. B., & Kiss, L. B. 2016. The Importance of the Monetary System Regarding

Sustainability. E-Conom, 5(2), 3–15. http://doi.org/10.17836/ec.2016.2.003

Schinasi, M.G.J., 2013. Responsibility of central banks for stability in financial markets (No. 3-

121). International Monetary Fund.

Strauss, D. 2020, January 9. Carney says BoE could commit to 'lower for longer' rates strategy.

Retrieved March 16, 2020, from https://www.ft.com/content/34f234fc-32d9-11ea-9703-

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Yellen, J.L., 2014. Monetary policy and financial stability. Washington, DC: International

Monetary Fund.