Sunday, June 2, 2019

UK Interest Rates During the Financial Crash

UK Interest Rates During the Financial CrashCentral banks always keep back responsibility to keep a stable preservation which includes stable prices, low splashiness footstep and confidence in the local parsimony. The main beak used by central banks for these propose is m mavintary policy which exit influence the bear on dictate, and the way of carry on it varies from country to country. This essay will anticipate into the desire of England and explain the transmission of monetary policy and how the policy affected by the honorable mention crunch.The banking concern of England gained its independent right to set up interest footstep according to the target inflation rate since May 1997. The preferred target inflation rate in the United Kingdom is 2% and the argot of England sets appropriate interest rate to ensure the real inflation rate is moving towards the target inflation rate in an acceptable judgment of conviction period. However, the indomitable target infl ation rate does not necessary mean a constant interest rate. An Overview of the change of interest rate in UK banks from 1973 to 2009, from which a vary trend could be observed among the whole period and there was a sharply decrease from nearly 15% to 5% during 1989 to 1993 when the United Kingdom was experiencing an economy recession. After 1993, the interest rate was relatively stable until 2008. However, between 2008 and 2009 the interest rate deeply drops from 5.25% to 0.5% for the recent credit crunch. From the data from the Bank of Englands report, the interest rate decreased at a rate of 1% per month constantly from October 2008 to January 2009 after the Lehman Brothers bankrupt.It is well known that a low interest rate represents a loose monetary policy which is aim to increase the inflation rate and the economy. It whitethorn illustrate how the interest rate set by the Bank of England conduct the monetary policy. The official rate set by the Bank of England direct influenc e the market rates includes the repo rate, bond rate, inner bank borrowing rate and so on. Then the market rate sets the asset prices in the financial market which will in turn affects states expectations of the economy. Also, the official rates would give people the signal about how will the market moves. For instance, a decrease in official rate will shows a loose monetary policy to the unexclusive and people would expect a rise in the price level and then whitethorn increase their domestic consuming beg. In addition, the official rate change will affect the exchange rate directly for it alters the domestic investment rate.(Mishkin, 2006).At the second stage, the official rate indirectly affects the domestic demand and net external demand, which forms the total demand, via the market rates, asset prices, expectations and exchange rate. Then the total demand influences the domestic inflation rate. Finally, the domestic inflation and import prices steady down the inflation. For example, as mentioned above, a decrease interest rate will increase the publics domestic demand and also would decrease the exchange rate against foreign currencies which may consequently increase the export demand for the goods will be cheaper for foreign consumers. As a result, the total demand will increase and may ultimately raise the price level and lead to an increase in inflation rate.Timing effect is another factor that the Bank of England concerns for the monetary policy. That is to say, the personal effects of changing interest rate are not instantly but take time to ripey function. Some channels may be more(prenominal) subtle to the change while others may not. The Bank of England estimates that a monetary policy may takes up to 2 years to be fully influence the inflation rate. The past statistic data supports this view that the inflation rate was nearly 2.3% in 2007 and increased to 2.9% in March 2009 during which period a sharp decrease in interest rate could be ob served.The reason for this sharp dec suck of interest rate from 2008 to 2009 is mainly accounts for the credit crunch recently. The credit crunch shows a hearty shortage in expectant supply and declining quality of borrowers financial health (Mizen, 2008). Also, the credit crunch gives very bad expectation to the public about the economy and the price of real estate was declining relatively. Consequently, investors are lack of motivation to invest for the low earnings due to the declining prices and a high peril for the credit crunch. On the other hand, for the householders may feel little wealth for the decreasing prices and lack of sense of the financial safety, they may reduce the consuming and prefer to deposit in the bank. Both phenomena are not preferable for a growing economy in that the Bank of England cut the rate sharply to increase the supply of capital and wish to encourage the amount of invest and consume to cease the recession. In fact, the GDP result rate from 20 08 to 2009 was only 0.7% and the growth rate from 2007 to 2008 was 3% (Fedec, 2009). The growth in the first quarter in 2009 was even worse, which was 4.1%, that may be the reason for the Bank of England cuts the rate to 0.5%, which was only one tenth compared to the same time last year. As the data shows the inflation rate rose in response to the loose monetary police, the GDP growth rate may not be very optimistic for the pessimistic among the public.ReferencesBank of England, 2008 How Monetary Policy Works, Bank of England, http// of England, 2009 Base Rate, Bank of England, http// of England, 2008 Monetary Policy Framework, Bank of England, http// A,2009, No End Yet to British Resession, TradingEconomics, http// Growth.aspx?Symbol=GBPMizen P, 2008, The Credit Crunch of 2007 2008 A Discussion of the Back ground, Market Reactions, and Policy Responses, Federal Reserve Bank of St. Louis Review, 90(5). pp.531 67 Mishkin, F.S., Eakins, S.G. 2006, Financial Markets and Institutions, Fifth Edition, Pearson International Edition, pp. 219 244. RateInflation, UK Historic Inflation Rate, RateInflation http// rate/uk historical inflation rate.php?form=ukirPart BSecuritization started from 1970s firstly in the US market and then also trivial in the Europe after the new rules was adopted. It is welcomed by most banks because it brings additional way for banks making profits and it is an off balance sheet activity. However, due to variety risks associated with securitization and the interminable re securitization, it may lead to sever financial crises. In fact, this would be the main reason for the Northern Crisis and the recent credit crunch (Mizen, 2008). This essay will first introduce the process of securitization then explain the risks in the process with a special focus on mortgage backed securitization and discuss its effects in the credit crunch.The definition of securitization is quite straightforward it is the process of pooling and repackaging loans into securities that are then sold to investors (Ergungor, 2003). in that location are many assets would be securitized such as mortgages, home equity loans, manufactured housing loans, credit card receivables and so on. By securitization, banks are able to sell those illiquidity assets to different investors. Besides, banks would create derivates by pooling assets together. There are variety types of securitization depending on the backed asset or payment method. For instance, the most popular type of securitization is Mortgage Backed Securitization (MBS), and there are plus Backed Securitization (ABS), and Collateralized Debt Obligation (CDO).Basically, the progress of mortgage backed securitization creates a mortgage pool and the agency sells shares of the p ool to different investors according to their preferences. Then the cash flows from the mortgage passed along to investors (Van, 1998). Agencies usually pooled together mortgage and divide those payments into several parts and develop different cash flows to create different type of securities which may have different maturity or yields, and sell them to investors with different risk attitude. The total sum of cash parts will be equal to the whole.The progress of securitization brings significant benefits to banks. First of all, as banks are regulated to meet the minimal capital requirement which may reduce profits banks would earn. As a result banks may prefer to engage in securitization which is off balance sheet so that do not require banks to meet the capital requirement and gives a more attractive opportunity for banks earning. On the other side, investors prefer less risky and higher return which could be fulfilled by buying the debts through securitization. It is less risky for it is backed by mortgage and has a higher rate than deposit. Besides, as the Great Depression and bank fails not very long before, investors no longer consider deposit in the bank as a safe heaven (Ergungor, 2003).In this procedure, agencies do not really have exist except transaction costs which will be induced from investors. In addition, if another investor buys a share, he may also securitize it and sell it to others. In that way, one mortgage would be re securitized many times. Consequently, if one mortgage fails to repay, many securities may face the risk of default which to rough extend enlarge the risk to the whole financial system. In contrast to default risk, agencies also face refund risk in the process. To be more specific, for example, if the borrower expects the interest rate would amount then he may repay the debt early to refinance in a lower cost, meanwhile, agency are suppose to produce constant repayment periodically to investors who buy the MBS. As a resu lt, the agency have to reinvest the amount of money repaid early by borrowers and which forces them engage in a reinvestment risk in case the interest rate may fall.Mizen(2008) points out that the credit crunch started from 2007 is very complicated for now there are many financial innovations grown ways to packaging and reselling assets. Then he argues that the main reason for these financial crises is mispricing risk of the products which are mortgage backed securities. Historical events show that the beginning of this credit crunch was a serial of mortgage defaults. Then these defaults bring downgraded subprime related mortgage products which then lead to countrywide mortgage bank losses in the U.S. However, this trend did not stop it soon spread to European banks which have tight relationship to the U.S. financial markets. It is acknowledged that the Credit crunch of 2007 2008 develops after this the full scale (Mizen, 2008).The amount in billions of dollars of household credit market debt outstanding from 1950 to 2009. It could be seen that the trend of growing was much shaper after 2000 and peaked in 2009 when the approximately $11 trillion is mortgage debt (house of cardss, 2008). It is not hard to imagine that 1% of the total amount of mortgage debt was securitized and only 1% of the securitized debt was re securitized when some of them default, how great the amount of dollars would be involved in. That was what happened in the Credit Crunch, for a trivial subprime mortgage market, financial institutions are tied in a line and the re securitization strength this tie and increase the risk and the price of default. Once one default, the whole will suffer, the globalization also enlarges the scale that will suffer.ReferencesBubble H,2008, A Decade of Slow Growth Why the United States will Face a Decade of Economic Stagnation and Face a L Shaped Recession. 10 Charts and Pictures as to Why This will Occur., http// decennary of slow growth why the united states will face a decade of economic stagnation and face a l shaped recession 10 charts and pictures as to why this will occur/Ergungor E,2003, Securitization, Federal Reserve Bank of Cleveland, August 15, 2008Mizen P, 2008, The Credit Crunch of 2007 2008 A Discussion of the Back ground, Market Reactions, and Policy Responses, Federal Reserve Bank of St. Louis Review, 90(5). pp.531 67Van H, crowd together C (1998), Financial Market Rates and Flows, Chapter 13, PP 119. Prentice Hall

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