4.2.4 Flashcards
1
Q
What is money?
A
Money is an anything acceptable in the settlement of a debt or payment. An IOU
2
Q
Functions of money
A
- Medium of exchange
- Means of payment
- Store of value
- Standard of deferred payment
3
Q
Characteristics of money
A
- Portability
- Divisibility
- Acceptability
- Durability
- Scarcity
- Stability in value
4
Q
What is liquidity
A
The ease in which as asset can be converted into cash without loss of value
5
Q
What is the most liquid asset
A
- Cash
6
Q
Examples of less liquid assets
A
- Savings
- House
7
Q
What is the money supply
A
The stock of financial assets which function as money
- Narrow money is highly liquid money
- Broad money is less liquid money
8
Q
What are financial markets
A
Markets that enable transfers between those who deposit funds and which to borrow money
9
Q
Types of financial markets
A
- Money markets
- Capital market
- Foreign exchange market
10
Q
Money market
A
Buying & selling short term financial assets (loans/overdrafts)
11
Q
Capital market
A
Buy and sell medium term financial assets (large business loans)
12
Q
foreign exchange market
A
Deals with transactions requiring conversion from one currency into another currency
13
Q
Debt v Equity
A
- Debt is when you borrow money and has to be paid back.
- Equity is when a company raises finance by selling a share in the company
14
Q
How can a company raise money using debt ( borrowing)
A
- They can borrow from the bank
- They can issue corporate bonds which investors can buy
15
Q
How can a company raise finance through equity
A
- Selling a percentage of the company to investors through shares
- they don’t have to pay they money back
16
Q
What are treasury bills
A
A very short term form of borrowing by the govt, usually repaid within 3 months
17
Q
What are spot and forward markets
A
- spot markets are immediate conversion from one currency to another
- forward markets are when its agreed that currency will be converted at a specific time in the future.
18
Q
Bonds
A
are issued by firms and govt wishing to borrow money.
19
Q
Maturity
A
When the final interest on a bond must be paid
20
Q
Coupon rate
A
annual interest rate received on a bond
21
Q
What are corporate & govt bonds
A
- corporate bonds are issued by firms to finance investment for expansion of business
- govt bonds are issued by the govt to finance a fiscal deficit
22
Q
What is the interest received on a bond
A
yield
23
Q
How is yield calculated
A
Coupon/ market price X 100
24
Q
What is the relationship between market value of a bond and yield
A
Inverse relationship
- market value rises or falls depending on the demand
25
Commercial banks
Referred to as high street banks.
- they accept deposits from the general public and lend money to ppl who want to borrow
26
Primary functions of a commercial bank
- accept deposits
- lend to economic agents
- provide efficient means of payment
27
Investment bank
A bank that provides financial services to other businesses by issuing new capital (share or bonds)
28
What is a balance sheet
A list of all the assets, liabilities and owners equity at the end of they year ( net worth of the company)
29
Examples of assets
- Cash
- Balances
- Loans
- Bills
- Investments
- Advances
- Fixed assets
30
Liquidity
how easily an asset can be converted into cash without any loss in value
31
What is a liability
Something which must be paid. What the bank owes to ppl
32
Examples of liabilities
- Shared capital
- Retained profit
- Long term borrowing
- Short-term borrowing
- Deposits
33
Objectives of commercial banks
- liquidity
- profitability
- security
34
Profit-liquidity trade off
The more money a bank lends out, the more profit it could make, but the less cash it has to pay consumers who deposited money (less liquidity)
35
Liquidity ratio
Liquid assets/ deposits
36
Why would a low liquidity ratio be bad for a bank
Because if consumers want to withdraw their money, the bank wouldn’t have enough money and they would either fail or the govt would have to help them out
37
What does capital ratio measure
how much capital the bank has compared to its loan
38
How do you know if the capital ratio is high
If there is more capital than loans
39
Why is a low capital ratio bad for a bank
Becasue if the bank needs to repay consumers or is running low on cash, it can’t rely on the owners money (capital) so it will likely go bankrupt
40
Central banks
the bank of an economy responsible for the issue of money and management of monetary policy.
EG: Bank of England
41
Functions of the UK’s central bank
- to maintain financial stability
- to help the govt maintain macroeconomic stability
42
How does the BoE ensure financial stability
By acting as the ‘lender of last resort’ to the banking sector - providing money for short term needs and liquify insurance, so the central bank makes available liquid assets for banks that need access to those funds
43
What is monetary policy
Changes in interest rates,money supply, exchange rate, & QE by the central bank to influence AD
44
Who is inflation rate set by
The government
45
Objectives of the monetary policy
- To achieve the govt inflation target of 2% per yr
- full employment and steady economic growth but using monetary policy and if they don’t conflict with inflation target
46
The Monetary Policy Committee
- the level of interest rates is set monthly by the MPC of the BoE
- they consider how a range of economic factors will impact the UK’s inflation rate
47
How do changes in interest rates affect the exchange rate?
- When interest rates go up, exchange rates go up cause high interest rates attracts hot money
- When interest rates go down, exchange rates go down
48
Why might changes in interest rates not be guaranteed to work
They aren’t guaranteed to work immediately or exactly as planned because they are based on consumer behaviour , which is not always predictable
49
Why did the bank lower interest rated during GFC 2008
Had to use expansionary monetary policy to get positive economic growth, so they deceased the base interest rates, early 2008 the base rate was 5.5% until march 2009 it went all the way down to 0.5%. As lower interest rates mean ppl will will receive lower for their returns in savings so their MPC will increase
50
51
Who is responsible for achieving the inflation target?
-Bank of England - Monetary policy committee
52
What is hot money
Currency that moves quickly and regularly between financial markets so investors can gain the highest short term interets rates.
53
What happens when there’s a weak pound
- Balance of trade increases
- short run economic growth
- AD rises
- unemployment decreases
- SRAS shifts left
54
What happens when there’s a strong pound
- Balance of trade decreases
- unemployment increases
- AD falls
- demand pull inflation goes down
- SRAS shifts right
55
What is expansionary monetary policy
Policies to increase AD
- creating demand-pull inflation
- reducing interest rates
56
What is contractionary monetary policy
Policies to reduce AD
- reducing demand-pull inflation
- increasing interest rates
57
What is the transmission mechanism
The process by which a change in bank rates filters through the economy to affect the rate of inflation
58
Explain the transmission mechanism when bank rates are lowered
- Lower borrowing costs, incentives less saving & increase marginal propensity to consume.
- Saving interest rates falls, reduces incentive to save, consumption.
- Mortgage rates fall, households pay less, increases consumption as more disposable income.
- Lower interest rates on business loans, increases incentive for business to borrow.
- Weaker exchange rate - ppl save less, and look to move money out of country (hot money outflows) depreciating currency
59
What diagram could be used to show when bank rates are lowered (expansionary MP)
- LRAS curve
- AD shifting to the right
60
What is quantitative easing
- Used by banks to stimulate the economy when monetary policy isn’t effective
- The BoE electronically creates the money
- Uses it to buy govt and bank bonds
61
What happens after quantitative easing
- As banks now have more money, they will naturally lend more to households and firms, increasing the overall demand which restimulates the economy.
62
Limitations of QE
- Cost push inflation - as depreciation in Uk currency on FOREX markets
63
What is the funding for lending scheme?
The UK had high funding costs,so the govt introduced this scheme so banks can increase lending to boost economic activity
64
What is forward guidance?
Used by central banks to detail what the future monetary policy will be. With the intention of reducing uncertainty in the market
65
Factors considered by the MPC when setting bank rates
- unemployment rate
- savings rate
- consumer spending
- exchange rates
- high commodity prices
66
What is a liquidity trap
When monetary policy becomes ineffective, interets rates can’t fall further
67
How do changes in the exchange rate affect AD
- A reduction in the Ex rate causes exports to be cheaper, which increases exports. So demand for exports is price elastic
- also causes imports to be expensive. So the UKs current account deficit will improve
- However, its inflationary due to an increase in the price of imported raw materials.
68
What is the trade off of expansionary monetary policy
- Demand - pull inflation
- Current account deficit - more growth, incomes rising, spending more on imports
69
What would Keynesian economists argue against expansionary monetary policy?
- Interest rates have a lower bound and enter a liquidity trap
- This is because when IR are very low economic agents have already converted their in-liquid assets to more liquid assets like cash to either spend, save or invest due to lack of security/ uncertainty about future.
70
Evaluation of expansionary monetary policy
- Depends on the size of the output gap- if IR are cuts and economy has small negative output gap there won’t be much growth and high demand-pull inflation
