2 - The Role of Government Flashcards
What are the two main functions that the Government has in the financial markets?
1 - Managing the economy: Financial markets work more effectively in a well-managed economy and lenders and investors are willing to invest in a stable economy.
2 - Regulation: Making sure that high standards are kept and appropriate behaviour and consumer protections are in place.
What are the objectives of economic policy?
Price Stability: Low and controlled inflation to avoid rising prices.
Low unemployment: Full employment, higher tax returns to the public purse and keeping down welfare costs.
Balance of payments: Making sure the imports/exports deficit/surplus isn’t meet an equilibrium.
Economic growth: Raising standards of living and keeping unemployment low.
Explain what fiscal policy is?
Fiscal policy (sometimes called budgetary policy) is the process by which the government attempts to influence the level of economic activity through government spending, taxation and borrowing.
What is the balance of payments?
The balance of payments is the record of one country’s trade with the rest of the world;
in the case of the UK, it is calculated in sterling. Money coming into the country is known
as a credit; money going out is known as a debit. The current account records trade in
goods and services; goods are known as visible trade and services as invisible trade.
What are the ways of controlling a deficit in the balance of payments?
Increasing interest rates to encourage overseas investment – this brings foreign
currency into the UK, but can have a negative effect on the UK economy because higher interest rates make borrowing more expensive and may reduce spending. It is also likely to make sterling stronger – this makes exports more expensive and imports cheaper, which can actually increase the deficit. In tough economic times, the government is likely to try to reduce interest rates to encourage spending.
Imposing tariffs and import quotas – with tariffs, the government effectively
sets a charge on imports, making them more expensive and less attractive; with
quotas, the government sets limits on the number of certain goods that can be
imported, with the principle of supply and demand usually leading to higher prices.
Both measures are designed to make imported goods less attractive and encourage buyers to look at domestic supplies. This is often referred to as ‘protectionism’ and is very much against the principles of a free market.
Imposing exchange controls – whereby the government interferes with free currency
markets by pegging (tying) the domestic currency to another currency, such as the
US dollar. This allows the government to control the relative value of the currency
and so determine how cheap or expensive its goods are.
What is monetary policy?
A series of actions taken by the government that affects the supply and price of money. Monetary policy today is more likely to relate to interest rate policy, through the BoE and the Monetary Policy Committee that meets eight times a year to decide on whether to increase or decrease the Bank rate, or to leave it unchanged.
What really happens when the BoE changes the interest rate, what is really being changed?
The technical aspect of what is being changed is the 14-day gilt repo rate, which has a knock-on effect on rates within the economy.
What is QE?
Quantitative Easing: Whereby the Govt buys corporate bonds, which allow the company to spend more which produces inflows of cash back into the banking sector, which in turn gets lent out.
What are the negatives of Quantitative Easing?
Has a knock-on affect on the annuity rates which tend to be linked to corporate bonds. As the yield is reduced, by the Govt’s intensive buying of bonds, this, in turn, reduces the amount of money people receive from their pensions.
Low-interest rates (which are linked to the 14-day gilt repo) are also affected savers as they get less return on their savings.
It can also raise prices by increasing inflation.
What is inflation?
It is the rise in the cost of goods over time.
What is meant by Disinflation?
Is the term using for falling inflation - is not deflation. Where there is disinflation, prices can still rise but not at the previous rate.
What is Deflation?
Deflation is a sustained period of prices over a sustained period, which also tend to run along side falls in output and demand within the overall economy. Essentially, people start to hold onto their money, in the hope of cheaper prices, which causes prices to fall.
What are the three symptoms of inflation?
prices of goods and services are rising; people’s incomes are rising, and the money supply is rising.
How is inflation measured?
Retail Prices Index (RPI): Basically a ‘basket of goods’ that people tend to buy. These are monitored at hundreds of outlets and measure for signs of increasing or decreasing.
RPIX (underlying rate of inflation): The RPI minus the Mortgage repayments.
Average Weekly Earnings (AWE): Measuring the rate of change of short term earnings growth. AWE tends to rise before the RPI does, but if there is a strong rise in the RPI, the AWE may not reflect it fast enough.
Consumer Price Index (CPI): The CPI replaced the RPIX as the measure of inflation targets. Similar in function to the RPIX, but uses different weighting and uses a standardised European standard Harmonised Index of Consumer Prices (HICP).
The RPI and CPI are calculated each month, using 180,000 price quotes on 680 products
sourced from 20,000 shops, services providers and internet outlets. The contents of the ‘basket’ are updated each year to reflect current spending patterns. Each measure is based on samples of the population, although there are slight differences in the profiles used.
Why are interest rates an integral part of Monetary Policy?
They provide the price for borrowing and lending. The rate of interest is the equilibrium price that prevails in any particular financial market that brings lenders and borrowers together.
