Ch 3 Flashcards
What are the four main phases of the business cycle?
1) Recovery (followed by expansion or acceleration)
2) Boom
3) Slowdown/contraction
4) Recession
What are two effects of globalisation?
1) Investors can invest in foreign markets
2) Disadvantage low-skilled, labour intensive industries in developed world
What is GDP?
Total value of all goods and services produced domestically during calendar year
What is PSNCR?
Public Sector Cash Net Requirement - difference between gov’s expenditure and revenues
If expenditure>revenue = PSNCR grows
If expenditure
If the country is in recession, what will the public finances be like?
- Tax revenues weak
- Spending on unemployment rises
- PSCNR will grow
If economy is expanding, what will the public finances be like?
- Tax revenues rise
- Spending on unemployment falls
- PSCNR falls
When is the economy said to be contracting?
When GDP falls compared with previous quarter
When is the economy said to be in recession?
Two successive quarters of declining GDP
When is the economy said to be expanding?
When GDP rises compared with the previous quarter
What happens to fixed interest securities when the economy is booming?
Yields increase, price decreases
What happens to fixed interest securities when the economy is falling?
Yields decrease, price increases
What happens to the prices of equities as the economy moves out of recession?
Generally, equities strengthen as the economy expands when interest rates remain low
What is fiscal policy?
Use of government spending and taxation to influence both the both the level of demand in the economy and level of economic activity
How does the government use fiscal policy in a recession?
Increase spending/cut taxation
How does the government use fiscal policy in a boom?
Reduce spending/increase taxation
How does fiscal policy affect individuals and companies?
- Individuals: the different tax treatment of the various types of assets will influence investment decisions
- Company: the tax treatment of a company’s earnings will affect its dividend policy, and its choice of raising capital through debt and equities
What is monetary policy
Attempt to stabilise economy by controlling interest rates and the supply of money
Who sets interest rates?
Monetary policy committee
What is LIBOR?
The rate at which banks lend to each other
How does the Bank of England ease monetary policy?
Reducing short term interest rates
How does the Bank of England tighten monetary policy?
Increasing short term interest rates
What is money supply?
The quantity of money available within the economy to purchase goods and services
What is M0 also known as?
Narrow money
What is M4 also known as?
Broad money
What are the most commonly quoted measures of money supply in the uk?
M0 & M4
What is M0 (money supply measure)?
- Includes notes and coins in circulation plus banks’ operational deposits with the Bank of England
- Reflects changes in the economic cycle, little effect on national output or inflation
- Is an indicator of consumer spending and retail sales
If there is a growth in M0, what does this indicate?
Consumer spending is buoyant
If there is a contraction in M0, what does this suggest?
Consumers are behaving more cautiously
What is M4 (money supply measure)?
- Includes notes and coins in circulation plus banks’ operational deposits with the Bank of England PLUS the bank accounts of UK residents with UK banks and building societies
- Includes deposits created by banks and building societies through their lending activities, as well as deposits lodged in accounts by people wanting to save
- Acts as an indicated or the economy
What does a growth in m4 indicate?
Increased demand for loans
What is a rapid growth in money circulating in the economy often interepreted as?
Build up of inflationary pressures
What is the measure of inflation in the UK?
CPI
What does CPI measure?
Average change from month-to-month in the prices of consumer goods and services bought by consumers within the UK
What is the lead measure of inflation used by the ons?
CPIH (including owner occupiers housing costs)
What is disinflation?
When there is a decrease in the rate of inflation
What is deflation?
There is a decline/inflation rate becomes negative
What effect does inflation have on cash deposits?
- Inflation erodes value of capital invested
- Interest rates tend to rise and fall in line with inflation
What is a real return?
Return that exceeds rate of inflation
What affect does inflation have on fixed interest securities?
- Real value of capital will erode
- Fixed income and so purchasing power will decrease with inflation, therefore investor is better off if inflation reduces
- Prices tend to fall if inflation is deemed to be speeding up
What effect does inflation have on equities?
- Rising company profits will lead to increasing dividends and/or growth in capital value of shares
- Equities tend to offer real growth
What is the main tool used by central banks to control inflation?
Raising or lowering of short-term interest rates
What is falling interest rates usually a signal for?
That the economy will expand in the medium term as a result of lower costs of borrowing
How will falling interest rates affect cash deposits?
Make cash deposits less attractive
What is the relationship between the price of fixed interest securities and interest rateds
Inverse:
- Eg as interest rates increase, price of fixed interest securities decrease
What is the effect of lower interest rates on equities?
Company profits are usually higher as a result of the reduced cost of borrowing and higher demand
