The bank rate is the official minimum rate at which the bank of England will discount first class bills of exchange for its own customers. It is fixed by the bank court every Thursday. The bank rate is the most important of all rates for monetary loans, since all other money –market rates are based upon it.
The fund of money available for lending for short periods in the money market derives from bankers who set aside a proportion of their funds to be thus employed in the earning of profit for their shareholders. The original source of the bankers fund is of course, the customers of the banks at low interest or on current account without interest. But in as much as these deposit are repayable on demand or at short notice , the banks must provide reserves. This they do by keeping large cash reserves in their tills and with the bank of England. The reminder of their customers’ funds are employed as prudently as remuneratively as possible in the earning of interest. The banks must always have regard to the liquidity of their investments and so day to day loans for short periods , to members of the London Money Market are a sound mode of employing a proportion of their available funds. An increase in the bank rate is followed by an increase in the deposit rate and by an increase in the rate for loans to members of the money market. Similarly , a decrease in the bank rate is followed by a lowered deposit rate and a lowered market for money. But because business is largely carried on by the means of loans , frequent changes in the bank rate would have a disturbing effect on business contracts and so the bank rate is changed only when financial conditions are such that a change cannot be avoided. When England was on a full gold standard changes in the bank rate were frequent. Ignoring those demands for additional currency due to holiday requirements , harvest operations , e.t.c which regularly recurring are easily provided for , the bank had then in safe guarding the reserve to counteract when either occurred.
(a) An abnormal internal demand for currency consequent upon an inflation of credit or times of financial crisis, a public distrust of credit instruments.
(b) A strong foreign demand for gold arising from adverse state of the foreign exchanges.
(a) An abnormal internal demand for currency consequent upon an inflation of credit or times of financial crisis, a public distrust of credit instruments.
(b) A strong foreign demand for gold arising from adverse state of the foreign exchanges.
Sometimes both these conditions operated simultaneously, and then the monetary situation gave reason for anxiety. The chief means employed to correct such a situation was to increase the bank rate and if necessary to increase it effect of a rise in the bank rate and if necessary to increase it progressively till the desired result was attained. The effect of a rise in the bank rate (a) To induce the public to increase their deposit interest following upon the rise(b) To discourage borrowing
(c)To attract foreign gold to this country for investment. As regards
(a) and (b) Money was taken out of circulation or not put into circulation and reduced volume of internal currency caused a fall in internal currency caused a fall in internal prices, so that the home market became relatively a better market for buying than for selling. This encouraged the export trade. As regard
(b) the diminished outflow of gold to foreign countries and the increase in the money sent to this country for investment , combined with an expanding export trade in time corrected the adverse balance of international payments and brought about an equilibrium in the foreign exchanges or even a difference in favor of sterling. In this way the drain upon the bank’s gold was stayed, and its reserve was built up again to a safe proportion. From September , 1932 the gold standard was suspended and the bank was no longer concerned for its store of gold beyond the point of compliance with the legal requirement that all notes issued above the amount of the fiduciary note issue should be supported by gold bullion to equal to equal value. There could be no drain upon the bank’s stock of gold. The gold could be moved only by special operation either of the bank itself or of the government. The bank was however , just as concerned with the internal price level and the course of the foreign exchanges as when the country was on gold standard, but its method of control were changed to meet the altered circumstances. From the 30th of June 1933, until the advent of the first post -1945 consecutive government the bank rate was maintained at 2% almost continuously. The exceptional period was that following the outbreak of the second world war in 1939 it stood for a time at 3.88% and there were three changes in all. The post –1945 Labor governments followed a policy of cheap money and were guided by the principle that monetary weapons were ineffective. The conservative government has restored the bank rate to the exchequer’s armory with changes from 2% to two and a half percent to 4% and then back to three and half percent. These changes were made with the declared intention of affecting both the internal and external economic position of the country. With only 357,000 pounds sterling worth of gold as backing for the currency there was , of course , no longer any question of using the bank rate to protect it -quite apart from the fact that the gold was not free to be moved any way. When the state of the gold reserves was sometimes a source of concern , the bank rate was on occasions raised as high as 10% and there was an expression 7 percent will bring gold from the moon, but it is just an exaggeration. None the less a high bank rate failed to correct the position in 1931 and the gold standard had to be abandoned. From that time on it is true to say that the bank rate came to be regarded as a rather crude instrument and it was to a large extent supplanted by two others , the first of which had hitherto been used primarily to re-enforce the bank rate, these are as follows-
(c)To attract foreign gold to this country for investment. As regards
(a) and (b) Money was taken out of circulation or not put into circulation and reduced volume of internal currency caused a fall in internal currency caused a fall in internal prices, so that the home market became relatively a better market for buying than for selling. This encouraged the export trade. As regard
(b) the diminished outflow of gold to foreign countries and the increase in the money sent to this country for investment , combined with an expanding export trade in time corrected the adverse balance of international payments and brought about an equilibrium in the foreign exchanges or even a difference in favor of sterling. In this way the drain upon the bank’s gold was stayed, and its reserve was built up again to a safe proportion. From September , 1932 the gold standard was suspended and the bank was no longer concerned for its store of gold beyond the point of compliance with the legal requirement that all notes issued above the amount of the fiduciary note issue should be supported by gold bullion to equal to equal value. There could be no drain upon the bank’s stock of gold. The gold could be moved only by special operation either of the bank itself or of the government. The bank was however , just as concerned with the internal price level and the course of the foreign exchanges as when the country was on gold standard, but its method of control were changed to meet the altered circumstances. From the 30th of June 1933, until the advent of the first post -1945 consecutive government the bank rate was maintained at 2% almost continuously. The exceptional period was that following the outbreak of the second world war in 1939 it stood for a time at 3.88% and there were three changes in all. The post –1945 Labor governments followed a policy of cheap money and were guided by the principle that monetary weapons were ineffective. The conservative government has restored the bank rate to the exchequer’s armory with changes from 2% to two and a half percent to 4% and then back to three and half percent. These changes were made with the declared intention of affecting both the internal and external economic position of the country. With only 357,000 pounds sterling worth of gold as backing for the currency there was , of course , no longer any question of using the bank rate to protect it -quite apart from the fact that the gold was not free to be moved any way. When the state of the gold reserves was sometimes a source of concern , the bank rate was on occasions raised as high as 10% and there was an expression 7 percent will bring gold from the moon, but it is just an exaggeration. None the less a high bank rate failed to correct the position in 1931 and the gold standard had to be abandoned. From that time on it is true to say that the bank rate came to be regarded as a rather crude instrument and it was to a large extent supplanted by two others , the first of which had hitherto been used primarily to re-enforce the bank rate, these are as follows-
(a)Direct operations by the bank of England in the money market shortly referred to as the bank’s open market policy.
(b) Operation of the exchange equalization account.
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