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1. The Financial Services Industry > 2. Macroeconomic Analysis > Flashcards

2. Macroeconomic Analysis Flashcards

0
Q

Why is it important in national income accounting to distinguish between market value & final output?

A
  1. Final output distinguishes between final goods and those intermediate products or inputs used in a prior production process.
  2. It employs the concept of value added, which avoids any double counting in the national accounts.
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1
Q

What is GDP?

A

GDP measures the total market value of all final goods & services produced domestically, typically during a financial year.

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2
Q

What is the most common formula used for calculating GDP?

A

The expenditure method:

GDP = Consumption + Investment + Govt spending + (Exports - Imports)

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3
Q

What is GNP?

A

Gross National Product - on top of GDP, GNP includes contributions to an economy’s circular flow by its nationals - both firms and individuals - based overseas (known as net property income).

Therefore GNP = C + I + G + (X - M) + net property income

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4
Q

How is the difference between real and nominal GDP accounted for?

A

The GDP deflator (broadly based measure of inflation).

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5
Q

What are the main shortcomings of using economic growth as a barometer of national prosperity?

A
  1. Effects of economic growth may just benefit a narrow section of society rather than society as a whole.
  2. GDP & economic growth only capture those aspects of economic activity that are measurable. Therefore, both fail to account for:
    a) undesirable side effects of economic activity (e.g. pollution & congestion)
    b) non-marketable production such as DIY
    c) the subjective value attributed to leisure activities
    d) economic activity in the shadow economy (tax evasion = unrecorded activities)
  3. Complexity of collection the data & time it takes to do so
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6
Q

What does the rate of sustainable growth (trend rate of growth) ultimately depend on?

A
  1. The growth & productivity of the labour force
  2. The rate at which an economy efficiently channels its domestic savings & capital attracted from overseas into new & innovative technology & replaces obsolescent capital equipment
  3. The extent to which an economy’s infrastructure is maintained & developed to cope with growing transport, communication & energy needs.
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7
Q

What happens when an economy is growing in excess of its trend growth rate?

A

Actual output will exceed potential output, therefore resulting in inflationary consequences.

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8
Q

What happens when a country’s economic growth rate turns negative for at least two consecutive calendar quarters?

A

The economy is said to be in recession, or entering a deflationary period. This results in spare capacity & unemployment.

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9
Q

What are the five general stages in a typical economic cycle?

A
  1. Recovery
  2. Acceleration
  3. Boom
    (3a) . Overheating
  4. Deceleration
  5. Recession
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10
Q

What are the two main benefits of international trade?

A
  1. Specialisation

2. Competition

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11
Q

What is the difference between an open and a closed economy?

A 
An open economy is one where there are few barriers to trade or controls over foreign exchange. 
A closed (or managed) economy is characterised by protective tariffs & government intervention to influence the production of goods and services.
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12
Q

Why do governments sometimes engage in protectionism or the erection of trade barriers?

A

The believe that certain domestic industries, often those that are inefficiently run, should be protected against global competition.

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13
Q

What is the balance of payments?

A

The balance of payments is a summary of all economic transactions between one country and the rest of the world, typically conducted over a calendar year.

It is divided into two main components - the current account & the capital account

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14
Q

What is the current account used for (in balance of payments)?

A

The current account is used to calculate the value of goods & services that flow into and out of a country. This is usually divided into visible items (e.g. raw materials and manufactured goods) & invisible items (e.g. banking, financial services, tourism & other services).
To these figures are added other receipts such as dividends from overseas assets and remittances from nationals working abroad.

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15
Q

What do the results of the current account calculations provide?

A

Details of the balance of trade a country has with the rest of the world.
The visible trade is the difference between the value of imported and exported goods.
The invisible trade is the difference between the value of imported and exported services.

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16
Q

What is the difference between a trade deficit & a trade surplus?

A

Trade deficit = a country imports more than it exports

Trade surplus = a country exports more than it imports

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17
Q

What is the Capital Account (balance of payments)?

A

The capital account records international capital transactions related to investment in business, real estate, bonds and stocks.

They are usually divided into categories such as:

a) foreign direct investment
b) portfolio investment
c) other investments

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18
Q

What must happen for the balance of payments to balance?

A

The current account must equal the capital account plus or minus a balancing item, plus or minus any change in central bank foreign currency reserves.

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19
Q

What is the money supply?

A

The amount of money that exists in the economy at any point in time.

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20
Q

What is ‘money’?

A

Anything that is generally acceptable as a means of settling a debt.

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21
Q

What is a ‘fiat currency’?

A

A currency which has no intrinsic value but which is demanded for what it can itself purchase.

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22
Q

What are the two most commonly quoted measures of the money supply?

A
  1. Narrow money - represents monetary base & is made up of notes & coins in circulation plus overnight deposits.
  2. Broad money - consists of narrow money plus bank deposits & money market instruments.
23
Q

What is the reserve ratio?

A

When banks are only required to hold a small proportion of their deposits as reserves to meet day-to-day withdrawals.

N.B. They can lend out the significant remainder, as long as they meet the reserves required by each country’s central bank.

24
Q

What are three factors that affect the money supply?

A
  1. Reserve requirements (amounts that commercial banks are required to hold)
  2. Discount rate (the interest rate charged by the central bank when lending to commercial banks - a last resort practice)
  3. Government bond issues - central banks influence amount of money in circulation by the issuance and repayment of bonds & treasury bills.
25
Q

How do central banks control the money supply (monetary policy)?

A
  1. Impose qualitative & quantitative credit controls, changing the reserve ratio & imposing special deposits on banks so as to restrict the ability of the banking system to create credit.
  2. Setting the price of money - or base rate - through operations in the money markets; this they do through injecting or withdrawing liquidity to or from the banking system by either buying or selling short term bills or government bonds.
26
Q

What are stabilisation policies?

A

Policies implemented by the government to try and reduce the impact of short term cyclical fluctuations in economic activity. They are characterised under the broad head is of monetary & fiscal policy.

27
Q

What do governments use monetary policy for?

A

To control the supply & cost of money.

28
Q

What do governments use fiscal policy for?

A

To set their objectives on borrowing, spending & taxation.

29
Q

What do governments try to influence with fiscal policy?

A
  1. Aggregate demand & the level of economic activity
  2. The pattern of resource allocation
  3. The distribution of income
30
Q

Explain the two forms of fiscal policy (demand management).

A

a) A discretionary (proactive) approach to demand management is one that is deliberately implemented to either boost (expansionary fiscal policy) or restrain (restrictive/tight fiscal policy) demand.
b) A passive approach is one whereby spending automatically increases & tax revenue decreases as the economic cycle moves into its recessionary phase. (AKA automatic or built-in stabilisers)

31
Q

Explain the difference between neutral, expansionary & contractionary fiscal policy.

A
  1. Neutral - implies govt operating a balanced budget where spending is fully funded by tax revenues & where the overall effect of the budget is to have a neutral effect on the economy.
  2. Expansionary - involves the govt increasing govt spending to simulate economic activity, & funding this through borrowing to create a larger budget deficit.
  3. Contractionary (restrictive) - govt seeks to reduce level of economic activity by increasing taxes or reducing govt spending.
32
Q

What are the three practical problems associated with fiscal policy?

A
  1. Time lags - the length of time that elapses between recognising the need for action, implementing the appropriate policy & the policy impacting the economy can be so considerable that it can render fiscal policy a destabilising influence.
  2. Crowding out - if expansionary fiscal policy is financed through borrowing, this borrowing will increase the market rate of interest to the detriment of that element of business investment & some consumer spending that would have been undertaken at the lower interest rate.
  3. Higher future tax rates - expansionary fiscal policy may result in a higher future tax burden being imposed on the economy.
33
Q

What do central banks (or monetary authorities) seek to influence through monetary policy?

A
  1. The supply of money
  2. The availability of money
  3. The cost of money or rate of interest
34
Q

Name 3 of the tools that monetary policy uses to control interest rates & the total supply of money.

A

Sets interest rates
Adjusts the size of the monetary base
Sets bank reserve requirements

35
Q

Explain the difference between contractionary & expansionary monetary policy.

A

Contractionary - reduces size of the money supply or raises interest rates
Expansionary - increases size of money supply or decreases interest rates.

36
Q

What are some of the problems associated with monetary policy?

A

Central banks influence of money supply can be limited as a result of securitisation (firms raising finance through the issue of securities rather than bank loans)
The velocity of circulation of money is not stable or predictable in the short run due to: financial innovation, deregulation & structural changes in financial markets, as well as changes in the rate of the rate of inflation and rate of interest.
So, changes in the money supply do not directly translate into changes in the price level.
Time lag between need for action & implementation of policy having an effect on the economy.

37
Q

How are exchange rates determined?

A

By either using a:
fixed exchange rate system
or a
floating exchange rate system

38
Q

Explain a fixed exchange rate system.

A

A system whereby the exchange rate is fixed against another currency such as the dollar.
To maintain a fixed exchange rate, a govt needs to have a significant level of foreign currency reserves, as it will need to intervene actively in the markets to keep it at the fixed rate.

39
Q

Explain a floating exchange rate system.

A

A system whereby one currency is allowed to float freely in the market and find its own level. (Most countries currently operate within a system of managed floating).

40
Q

Name some examples of factors that can influence an exchange rate.

A
  1. Inflation
  2. Interest rates
  3. Change in competitiveness
  4. Balance of payments
  5. Speculation
  6. The relative strength of other currencies
41
Q

What is Purchasing Power Parity (PPP)?

A

PPP is a theory which states that the exchange rate between one currency and another is in equilibrium when their domestic purchasing powers at that rate are equivalent.

42
Q

What are the effects in the of a rise in the exchange rate? (When a currency appreciates in value).

A
  1. Exports become more expensive & so fewer goods will be demanded
  2. Imports become cheaper and so demand increases
  3. Aggregate demand falls, leading to lower growth
  4. Inflation falls because of the effect of cheaper prices for imported goods, lower aggregate demand & less demand-pull inflation.
43
Q

What are the effects of a fall in exchange rate of devaluation?

A
  1. More competitive exports, increasing demand for those goods
  2. More expensive imports, reducing demand for those goods
  3. Higher economic growth & rising aggregate demand
  4. Potential for rising inflation as increasing aggregate demand may cause demand-pull inflation, & imports are more expensive, causing cost-push inflation.
  5. An improvement in the current account balance of payments
44
Q

What is inflation?

A

Inflation is the rate of change in the general price level or the erosion in the purchasing power of money

45
Q

What are the economic costs that inflation imposes on society?

A
  1. It hinders the ability of price-mechanism to clear markets (ie reducing prices to be able to sell outstanding stock)
  2. It reduces the spending power of those dependant on fixed incomes
  3. Individuals are not rewarded for saving, as borrowers gain at the expense of savers
46
Q

What is the difference between the nominal and the real interest rate?

A

The nominal interest rate is the rate earned on an investment.
The real rate is when the effect of inflation is then deducted.

47
Q

What are the consequences of a negative real interest rate?

A
  1. It creates uncertainty, leading to firms deferring investment decisions and consumers’ spending decisions.
  2. Time is spent guarding against inflation rather than being devoted to more productive means
  3. Exported goods and services become less competitive internationally
48
Q

Explain the two types of inflation.

A
  1. Cost-push inflation - if a firm faces increased costs and in elastic demand for their output, the likelihood is that these rising costs will be passed on to the consumer. Consumers will then demand higher wages causing a wage price spiral to develop.
  2. Demand-pull inflation - when the economy is operating beyond its full employment level, prices are pulled up as a result of an inflationary gap emerging. This excess demand can often stem from the optimism that accompanies rising asset prices but has resulted from politically inspired tax cuts.
49
Q

What are the two most widely used measures of inflation?

A
  1. Retail prices

2. Producer prices

50
Q

What is disinflation?

A

Disinflation is an intermediate state where there is reducing rate of inflation.

51
Q

What is stagflation?

A

Stagflation is when inflation is combined with a slow-to-negative economic growth, resulting in unemployment and possibly recession.

52
Q

What are the 5 different types of unemployment?

A
  1. Structural unemployment - due to the changing nature of the economy where certain skills in particular sectors of the economy become redundant.
  2. Frictional unemployment - where workers are between jobs or cannot be employed due to disabilities.
  3. Keynesian unemployment - structural employment on a national scale as a result in aggregate demand, causing unemployment in manufacturers & service providers.
  4. Classical unemployment - when wages are prices too high
  5. Seasonal unemployment
53
Q

What is the natural rate of unemployment?

A

This is the rate of unemployment in the economy when the labour market is in equilibrium, so that all those who want a job can get one & any unemployment is purely voluntary.

54
Q

What responsibilities do central banks have?

A
  1. Act as banker to the national banking system by accepting deposits from and lending to commercial banks
  2. Act as bank to government
  3. Manage national debt
  4. Regulate domestic banking policy
  5. Act as lender of last resort to banking system (in financial crises)
  6. Sets official short-term rate of interest
  7. Controls money supply
  8. Issues notes and coins
  9. Holds the nation’s gold and foreign currency reserves to defend and influence the value of a nation’s currency through intervention in the currency markets
  10. Provide a depositors’ protection scheme for bank deposits
55
Q

Name the major G8 Central banks.

A
  1. Federal Reserve (FED)
  2. The European Central Bank (ECB)
  3. The Bank of Japan (BOJ)
  4. The Bank of England (BoE)
  5. The People’s Bank of China
  6. Bank of Russia
  7. Bank of Canada

1. The Financial Services Industry (4 decks)

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