Coursework: Monetary policy in Reference to Bank of England

Essay question for Part II (Monetary Policy) of Topics in Applied Macroeconomics (EC1004):

Based on what we have studied:

Analyse the Bank of England monetary policy from 2001 to 2012.

Could you comment on the speech below with respect to what you have learnt in these weeks? Would you apply Bernanke’s approach to the UK?

Provide data for each of the points you are making in your answer.

Refer to official data in your answer: these are accessible from the Bank of England (http://www.bankofengland.co.uk/statistics/index.htm) and relate your answer to theories studied during the module. Do not use other sources of data for your diagrams.

Chairman Bernanke’s Press Conference

Transcript of Chairman Bernanke’s Press Conference

December 12, 2012

CHAIRMAN BERNANKE. Good afternoon.

It’s been about three and a half years since the economic recovery began. The economy continues to expand at a moderate pace. Unfortunately, however, unemployment remains high. About 5 million people—more than 40 percent of the unemployed—have been without a job for six months or more, and millions more who say they would like full-time work have been able to find only part-time employment or have stopped looking entirely. The conditions now prevailing in the job market represent an enormous waste of human and economic potential. A return to broad-based prosperity will require sustained improvement in the job market, which in turn requires stronger economic growth. Meanwhile, apart from some temporary fluctuations that largely reflected swings in energy prices, inflation has remained tame and appears likely to run at or below the Federal Open Market Committee’s (FOMC’s) 2 percent objective in coming quarters and over the longer term.

Against a macroeconomic backdrop that includes both high unemployment and subdued inflation, the FOMC will maintain its highly accommodative policy. Today the Committee took several steps. First, it decided to continue its purchases of agency mortgage-backed securities (MBS), initiated at the September meeting, at a pace of $40 billion per month. Second, the Committee decided to purchase longer-term Treasury securities, initially at a pace of $45 billion per month, after its current program to extend the average maturity of its holdings is completed at the end of the year. In continuing its asset purchases, the Committee seeks to maintain downward pressure on longer-term interest rates and to keep financial conditions accommodative, thereby promoting hiring and economic growth while ensuring that inflation over time is close to our 2 percent objective. Finally, the Committee today also modified its guidance about future rate policy to provide more information to the public about how it anticipates it will react to evolving economic conditions. I will return to this change in our communication after discussing our decision to continue asset purchases.

Although the Committee’s announcement today specified the initial monthly pace and composition of asset purchases, it did not give specific dates at which the program may be modified or ended. Instead, the pattern of future asset purchases will depend on the Committee’s evaluation of incoming information, in two respects.

First, we expect to continue asset purchases until we see a substantial improvement in the outlook for the labour market, in a context of price stability. In assessing the extent of progress, the Committee will be evaluating a range of labour market indicators, including the unemployment rate, payroll employment, hours worked, and labour force participation, among others. Because increases in demand and production are normally precursors to improvements in labour market conditions, we will also be looking carefully at the pace of economic activity more broadly.

Second, the Committee will be monitoring economic and financial developments to assess both the efficacy and possible drawbacks of its asset purchase program. The Federal Reserve’s asset purchases over the past few years have provided important support to the economy, for example, by helping to keep mortgage rates historically low. The Committee expects this policy tool to continue to be effective and the costs and risks to remain manageable, but as the program continues, we will be regularly updating those assessments. If future evidence suggests that the program’s effectiveness has declined, or if potential unintended side effects or risks become apparent as the balance sheet grows, we will modify the program as appropriate. More generally, the Committee intends to be flexible in varying the pace of securities purchases in response to information bearing on the outlook or on the perceived benefits and costs of the program.

Unlike the explicitly quantitative criteria associated with the Committee’s forward guidance about the federal funds rate, which I will discuss in a moment, the criteria the Committee will use to make decisions about the pace and extent of its asset purchase program are qualitative; in particular, continuation of asset purchases is tied to our seeing substantial improvement in the outlook for the labour market. Because we expect to learn more over time about the efficacy and potential costs of asset purchases in the current economic context, we believe that qualitative guidance is more appropriate at this time.

In today’s statement, the Committee also recast its forward guidance to clarify how it expects its target for the federal funds rate to depend on future economic developments. Specifically, the Committee anticipates that exceptionally low levels for the federal funds rate are likely to be warranted “at least as long as the unemployment rate remains above 6½ percent, inflation over the period between one and two years ahead is projected to be no more than half a percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.” This formulation is a change from earlier statements in which forward guidance about the federal funds rate was expressed in terms of a date; for example, in the statements following its September and October meetings, the Committee indicated that it anticipated that exceptionally low levels for the federal funds rate are likely to be warranted “at least through mid-2015.” The modified formulation makes more explicit the FOMC’s intention to maintain accommodation as long as needed to promote a stronger economic recovery in the context of price stability, a strategy that we believe will help support household and business confidence and spending. By tying future monetary policy more explicitly to economic conditions, this formulation of our policy guidance should also make monetary policy more transparent and predictable to the public.

The change in the form of the Committee’s forward guidance does not in itself imply any change in the Committee’s expectations about the likely future path of the federal funds rate since the October meeting. In particular, the Committee expects that the stated threshold for unemployment will not be reached before mid-2015 and projects that inflation will remain close to 2 percent over that period. Thus, given the Committee’s current outlook, the guidance introduced today is consistent with the Committee’s earlier statements that “exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.”

Let me emphasize that the 6½ percent threshold for the unemployment rate should not be interpreted as the Committee’s longer-term objective for unemployment. Indeed, in the economic projections submitted in conjunction with today’s meeting, the central tendency of participants’ estimates of the longer-run normal rate of unemployment is 5.2 to 6.0 percent. However, because changes in monetary policy affect the economy with a lag, the Committee believes that it likely will need to begin moving away from a highly accommodative policy stance before the economy reaches maximum employment. Waiting until maximum employment is achieved before beginning the process of removing policy accommodation could lead to an undesirable overshooting of potential output and compromise the FOMC’s longer-term inflation objective of 2 percent. As the FOMC statement makes clear, the Committee anticipates that policy under the new guidance will be fully consistent with continued progress against unemployment and with inflation remaining close to the Committee’s 2 percent objective over the longer term.

Guidance on writing the essay

Word count: max 2000 words (+ or- 10%)

Deadline: 21st of March, 16:00 hours

Submission: e-copy via Moodle

Students can expect to receive their marks and feedback within three weeks of submission.

Your answer has to show that you have studied the material covered in class and that you are able to use it in your interpretation of ACTUAL economic phenomena. DO NOT write everything you know. Rather, show that you have acquired some of the instruments you need to be able to read this speech from an economist viewpoint.

1. Formatting

The essay must be word-processed, except for diagrams. Number the pages. Write your name and programme, and the date, the text of the question, and a word-count, which should include everything except the bibliography, on the first page. Start the text on the second page. Do not use foot- or end-notes: if it is relevant, include it in the text, if not, exclude it. Divide up your essay clearly – for example, it should be clear where the introduction and conclusion start and finish. The word-limit is 2,000 words. The School operates a ±10% policy, so the essay should be between 1,800 and 2,200 words.

2. Diagrams

If you wish to use one or more diagrams, use large – at least half-page – bold, clear, diagrams. They should have a title at the top and the source at the bottom.

This is an example:

Figure 2: Central bank interventions in the foreign market and reserve accumulation (Millions of US$) (1992-2001)

Source: BCRP (2011)

3. Structure

The essay should consist of at least two or three substantive sections, plus an introduction and conclusion to wrap the whole thing up nicely. “Tell them what you’re going to tell them; tell them; tell them what you told them.” The introduction should address the question, explaining what it means and how you are going to go about answering it. It will include a brief preview of the answer, and a statement of the structure of the essay. The conclusion will summarise the results of your work, and state succinctly ‘the answer’ you have given to the question. You may want to discuss the limits of that answer here. The introduction, like the conclusion, may be the last things you write, but it will often be the first thing the marker reads. All the sections, including the introduction and conclusion, but excluding the bibliography, should be numbered using the decimal system, i.e. 1, 2, etc. Any subsections should also be numbered – 1.1, 1.2, etc.

4. Bibliography and references

Please use the Harvard system of referencing, subject to one small modification explained below. You must include a bibliography. This will contain a list of the sources you have used, in alphabetical order of the family name of the first author of the item. If you obtained the item from the internet, say so. Every reference in the text should correspond to an entry in the bibliography and vice versa. Follow this pattern:

For an article

Andy Denis (2002) “Collective and individual rationality: Maynard Keynes’s methodological standpoint and policy prescription”, Research in Political Economy 20, December, 187-215.

For a book

Robert Skidelsky (1975) Oswald Mosley London: Macmillan; ch 23

Note that for a book, I want to see the chapter(s) or section(s) you have used. Including items just to pad out the list, when there is no evidence in the essay that you have actually used them, will be penalised.

For an internet resource

Andy Denis (nd) Amazon Customer review of Boudewijn Bouckaert and Annette Godart van der Kroon (Editors) (2000) Hayek Revisited, Edward Elgar. Downloaded 30 December 2011 from: http://www. amazon.co.uk/product-reviews/1858984491/.

Reference your work thoroughly throughout. Much of the point of written assessment is to see what you’ve been reading and what you’ve got out of it. Use the following pattern for a reference in the text of your essay:

… text text text, as suggested by Denis (2002: 210), although the contrary case has been made elsewhere (Skidelsky, 1975: 302). More text more text more text …

Please note the page number at the end of the inline reference. This is a modification of the Harvard system, which, in other respects, is a model you should follow religiously. Failure to reference properly defeats much of the purpose and I penalise this heavily. Plagiarism of any kind is cheating and will lead to disciplinary action. All coursework scripts will be submitted to Turnitin.

5. Standard of English

Please aim for English of a publishable standard. Spelling, grammar, syntax, capitalisation and punctuation when weak distract attention from – and often obscure – what you are trying to say. Read through your coursework before submitting it and, if in doubt, get someone else – someone whose first language is English – to look through it as well.

6. Clear logic

Even if you get the answer wrong, through misunderstanding some aspect of the question, you may still be able to demonstrate your knowledge of the topic and insight into the issues, by addressing the question in a clear and logical manner. On the other hand, you may know what the answer is, but if you can’t explain that in an orderly and coherent manner you are going to lose marks.

7. Material is well integrated

You may decide that there are several sub-topics that you need to address in order to answer the question fully. Your account should in that case make clear what the links are between the various parts of your answer, not just list them.

9. Relevance

Keep your eye on the ball: ensure that every paragraph, every sentence, every word does some work and makes a contribution towards answering the question. Do not just assume that it’s OK if vaguely related to the topic. “Answer the question, the whole question, and nothing but the question.”