Effect of a reduction in the Bank Rate and increasing bank holdings of UK government bonds on the UK economy
A reduction of the bank rate would cause an overall interest rate reduction in commercial banks. Increasing the bank’s holdings of government bonds increases the level of reserves R issued by the central bank into the economy. This would increase the monetary base M0, which consists of H = C +Rc + Rb, currency and reserves. The overnight interbank rate therefore also decreases. The Bernarke-Blinder model displays this effect on the money market equilibrium, (1/T)R=m(i B ,y) as the well as the good market equilibrium, y=C((i B ,R). A reduction in the overnight interbank and interest rate would increase the level of the goods market equilibrium, causing a rightward shift of the CC curve through the bank lending channel. Additionally, the increase in reserves would increase the level of the money market equilibrium, resulting in a rightward shift of the LM curve through the Keynesian interest rate channel. This suggests increased bank lending and positive effect on the econ...