Lecture 10

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Please note:
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For copyright reasons it may not be possible to reproduce all images.

TR
E APTLHACCLEY DOEF BUUSSEIFNUELS S
International Financial
Markets and Banking
L ESACRHNOI N
OGL
Juliane Thamm
SW 3.07, Ext.: 3889, juliane.thamm@strath.ac.uk

Office hours: see myplace for details and/or email for an appointment
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S T R AT H C LY D E B U S I N E S S S C H O O L
Lecture 10
Central Banks and Balance of
Payments
© Juliane Thamm – University of Strathclyde

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Central banks
• Keep the wheels of the financial world moving

• Issue money (bank notes and coins)
• Help set the domestic base rate of interest
• Maintain the stability of the financial system through open
market operations
• Sets the key benchmark interest rate for short-term lending.

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independence
central banks should be independent of political pressure
Independence has two operational components.
1.Monetary policymakers must be free to control their own budgets.
2.The bank’s policies must not be reversible by people outside the

central bank.
For instance: the U.S. Federal Open Market Committee’s decisions cannot be
overridden by the President, Congress or the Supreme Court.

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successful monetary policy
requires a long time horizon
knowing these tendencies,

governments have moved
responsibility for monetary policy
into a separate, largely apolitical,
institution
It seems to work , when measured

by inflation targets (see right). Source: Cecchetti and Schoenholtz (2011, p. 409)
http://students.aiu.edu/submissions/profiles/resources/onlineBook/e2U
4L8_Money-_Banking_and_Financial_Markets_4th.pdf
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Bank of England
UK’s central bank

founded in 1694, nationalised on 1 March 1946, and gained
independence in 1997
monopoly on the issue of banknotes in England and Wales since the
early 20th century
statutory responsibility for setting the UK's official interest rate since
1997; interest rates decisions are taken by the Bank's Monetary Policy
Committee (MPC)
More information: http://www.bankofengland.co.uk/Pages/home.aspx

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Bank of England
two core purposes — monetary stability and financial stability

Bank of England Act 1998 sets out responsibilities for monetary stability
Responsibility for financial stability is shared with HM Treasury (HMT)
Financial Services Act 2012 established the FPC (a BoE sub-committee), the
PRA (a subsidiary of the BoE), and created new responsibilities for the
supervision of financial market infrastructure providers; these reforms came
into force on 1 April 2013
Bank of England and Financial Services Act 2016 ended the nature of the PRA
as a subsidiary of the BoE (it is now fully part of the BoE) and established the
Prudential Regulation Committee (PRC)
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Financial Stability Functions

Risk assessment – monitoring current developments both in the UK and abroad
Risk reduction – reducing vulnerabilities and increasing the financial system’s ability to
absorb unexpected events
Oversight of Payment Systems
Crisis Management
Lender of last resort – as part of its central bank functions, the Bank may act as ‘lender of
last resort’ to financial institutions in difficulty, in order to prevent a loss of confidence
spreading through the financial system as a whole

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Financial Stability Functions

Financial Policy Committee

https://www.bankofengland.co.uk/about/people/Financial%20Policy%20Committee
Special Resolution Unit

https://www.bankofengland.co.uk/financial-stability/resolution
Financial Market Infrastructure Supervision

https://www.bankofengland.co.uk/financial-stability/financial-market-infrastructure-supervision
Financial Sector Continuity

https://www.bankofengland.co.uk/financial-stability/financial-sector-continuity

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Resolution
Banking Act 2009

Creating a “bail-in” tool
Implementing the EU Bank Recovery and Resolution
Directive (applies from 1 Jan 2015)

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Financial Market Infrastructure

Supervision
three main types of infrastructure overseen by the BoE:
Recognised payment systems
Securities settlement systems
Central counterparties (CCP)
the BoE will work closely with the FCA reflecting the FCA’s responsibilities for
the trading infrastructure and market conduct
BoE will also work closely with overseas authorities which have an interest in
UK-based systems that support global markets

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Financial Sector Continuity

•Waking Shark II
12 November 2013 - exercise to test the financial sector’s response to a sustained and intensive
cyber-attack
•Operation Resilient Shield

November 2015 - joint UK-US operation, co-ordinated by CERT, the Computer Emergency
Response Team, in both countries; will test the channels of communication between each
government, those governments and the banks they regulate, and the bank's communications with
each other
The CBEST framework, launched by the Bank of England in 2014, is now the primary method for
UK financial services organisations to voluntarily test their defences using advanced threat
intelligence and realistic attack simulations. https://www.bankofengland.co.uk/-/media/boe/files/news/2014/june/boe-launches-new-
framework-to-test-for-cyber-vulnerabilities

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Monetary Policy
The Bank of England can use the money markets as a tool of monetary
policy
The Bank provides liquidity to the banking sector by making short term
purchases of “eligible” bonds and bills
The Bank influences interest rates through the price (interest rate) at
which it is prepared to offer liquidity to the banking sector
These are known as “open market operations”

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Changes in Bank Rate, Minimum Lending Rate, Minimum Band 1 Dealing Rate, Repo Rate and Official Bank Rate 1,2,3,4
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Min Lending Rate
Min Band 1 Dealing Rate

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Repo Rate
14 Official Bank Rate
12 1 - Bank Rate, Minimum Lending

Rate, Repo Rate and Official Bank
Rate are interest rates. The Minimum
Band 1 Dealing Rate are discount
10 rates.
2 - Data refer to the miminum
%
published rate the Bank discounted

bills to relieve money market
8 shortages (excludes late assistance
and repurchase and sale
agreements).
3 - 16.9.92, UK leaves the European
Exchange Rate Mechanism. MLR set
6 at 12%, raised to 15% (with effect
from 17.9.92; never implemented).
4 - The official bank rate paid on
commercial bank reserves.
4
2017
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Date
https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate © Juliane Thamm – University of Strathclyde

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How Monetary Policy Works

Image:
https://www.researchgate.net/publication/312165208/figur
e/fig8/AS:668792254377999@1536463907840/The-
Transmission-Mechanism-of-Monetary-Policy-From-
Interest-Rates-to-Inflation.ppm

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Monetary Policy and the Exchange Rate

- there is no exchange rate target for the UK
- changes in policy interest rates still have an effect on the demand and supply of
currencies in FX markets
Monetary policy and the money supply

- currently no targets for the growth of the money supply
- since 2009 the BoE has operated a policy of quantitative easing as an extra tool of
monetary policy

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Quantitative Easing (QE)
As of September 2012, the Bank of England

had committed a total of £375bn to QE, while on
14 September 2012 the US Federal Reserve
said it would spend a further $40bn (£35bn) per
month. This was on top of the $2.3tn (£1.4tn)
the Fed had already put into QE since 2008.

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Images on this slide were from http://www.bbc.co.uk/news/business-15198789,

however the site has since changed and it now gives the same information
without the graphic
Image next slide:

https://c.files.bbci.co.uk/139DA/production/_112964308_o
ptimised-qe_boe-new.png

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Balance of Payments (BoP)

records financial transactions made between consumers,

businesses and the government in one country and the rest
of the world
Main parts: current account and capital account
Must balance

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The current account of the balance of payments comprises the

balance of trade in goods and services plus net investment incomes
from overseas assets and net transfers
The capital account tracks capital flows in and out of the UK. This
includes portfolio capital flows (e.g. share transactions and the buying
and selling of Government debt) and direct capital flows arising from
foreign investment. Under IMF definitions this capital account is usually
split into a capital account and a financial account. (further details can be found
in the IMF BoP Manual http://www.imf.org/external/np/sta/bop/BOPman.pdf)
Image on next slide:

http://www.teara.govt.nz/files/di-23954-enz_0.gif © Juliane Thamm – University of Strathclyde
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For the UK , the Office of National Statistics (ONS)

publishes
the BoP data in its Pink Book, for the current edition
see:
https://www.ons.gov.uk/releases/ukbalanceofpaymentsthepinkbook
2022
For the euro area the BoP is The UK’s current account deficit was £45.6 billion in
prepared by the ECB 2021, this equated to 2% of GDP.
(http://www.ecb.int/stats/external/balanc
e/html/index.en.html)
The total trade balance returned to a deficit of £17.6
billion or 0.8% of GDP in 2021, after a surplus of
£7.6 billion or 0.4% of GDP in 2020, as global
supply chains started to stabilise, but imports and
exports remained below pre-coronavirus (COVID-
19) pandemic levels.
Images on next four slides are screen shots from:

https://www.ons.gov.uk/economy/nationalaccounts/balanceofpayments/bulletins/unitedkingdombalanceofpayme
ntsthepinkbook/2022 followed by an image from:
https://upload.wikimedia.org/wikipedia/commons/thumb/3/32/Cumulative_Current_Account_Balance.png/600px-
Cumulative_Current_Account_Balance.png
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FX rate and the BoP

Changes in the FX rate affect the balance of payments although these effects
may lag in time.
When the home currency is strong, the price of goods & services of that
country’s goods in foreign markets rises and the country’s exporters find it
harder to sell their products overseas.
It is also cheaper for domestic consumers to buy imported goods and services
because their currency buys more foreign currency than it did before.
Therefore a strong currency may lead to a worsening of the balance of trade –

much depends on the value of price elasticity of demand for exports and
imports.

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next steps
Please review the lecture 9 & 10 material and complete the week 9
required reading, then attempt to answer the workshop 9 questions.
Try self-assessment quiz 9 and check out podcase 4.
Enter your ideas for the Survey home work – final chance!
… and attend the next session!

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further help:
Come to any office hours – these are drop-in sessions, no appointment

needed! All details are on the AG991 myplace page.
Send any questions you may have by e-mail.
If you wish to see me outside of office hours, please e-mail to make

arrangements.
Appendix (optional):
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Reserve Currencies
a foreign currency held by a government or central bank as part of a country’s reserves
the US dollar is the most common global reserve currency, but the Euro is increasingly
widely used
the SDR is a reserve currency administered by the IMF
these holdings of foreign currency form part of the financial assets which a country
holds with respect to the rest of the world
with large foreign exchange reserves, a country can target a certain exchange rate
if a country holds substantial foreign debt, holding foreign currency reserves can help to
give more confidence in the country’s ability to pay

SDR
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IMF’s special drawing rights (SDR) basket, determines currencies that countries can receive as
part of IMF loans
reviewed every 5 years to ensure that basket reflects the relative importance of major currencies
in the world’s trading and financial systems
central banks with SDRs in their reserve accounts can convert those SDRs into one of five
currencies*:
U.S. dollar 43.38 % (41.73 %)**
Euro 29.31 % (30.93 %)
Chinese renminbi 12.28 % (10.92 %) For more optional information see:

https://www.imf.org/en/About/Factsheets/Sheets/2
Japanese yen 7.59 % (8.33 %)
023/special-drawing-rights-sdr
Pound sterling 7.44 % (8.09 %)
*as of 1st August 2022
** in brackets the percentage at the 2016 review


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For copyright reasons it may not be possible to reproduce all images.

SW 3.07, Ext.: 3889, juliane.thamm@strath.ac.uk

© Juliane Thamm – University of Strathclyde

• Keep the wheels of the financial world moving

© Juliane Thamm – University of Strathclyde

central banks should be independent of political pressure

Independence has two operational components.

1.Monetary policymakers must be free to control their own budgets.

2.The bank’s policies must not be reversible by people outside the

© Juliane Thamm – University of Strathclyde

requires a long time horizon

knowing these tendencies,

It seems to work , when measured

UK’s central bank

© Juliane Thamm – University of Strathclyde

two core purposes — monetary stability and financial stability

Financial Stability Functions

Risk assessment – monitoring current developments both in the UK and abroad

Oversight of Payment Systems

© Juliane Thamm – University of Strathclyde

Financial Stability Functions

Financial Policy Committee

Special Resolution Unit

Financial Market Infrastructure Supervision

Financial Sector Continuity

© Juliane Thamm – University of Strathclyde

Banking Act 2009

© Juliane Thamm – University of Strathclyde

Financial Market Infrastructure

© Juliane Thamm – University of Strathclyde

Financial Sector Continuity

•Operation Resilient Shield

© Juliane Thamm – University of Strathclyde

These are known as “open market operations”

Min Band 1 Dealing Rate

14 Official Bank Rate

12 1 - Bank Rate, Minimum Lending

published rate the Bank discounted

https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate © Juliane Thamm – University of Strathclyde

How Monetary Policy Works

© Juliane Thamm – University of Strathclyde

Monetary Policy and the Exchange Rate

Monetary policy and the money supply

© Juliane Thamm – University of Strathclyde

Quantitative Easing (QE)

As of September 2012, the Bank of England

© Juliane Thamm – University of Strathclyde

Images on this slide were from http://www.bbc.co.uk/news/business-15198789,

Image next slide:

© Juliane Thamm – University of Strathclyde

Balance of Payments (BoP)

records financial transactions made between consumers,

Main parts: current account and capital account

© Juliane Thamm – University of Strathclyde

The current account of the balance of payments comprises the

Image on next slide:

For the UK , the Office of National Statistics (ONS)

Images on next four slides are screen shots from:

FX rate and the BoP

Therefore a strong currency may lead to a worsening of the balance of trade –

© Juliane Thamm – University of Strathclyde

Try self-assessment quiz 9 and check out podcase 4.

… and attend the next session!