Ch 3

Question 1

What are the four main phases of the business cycle?

Answer 1

1) Recovery (followed by expansion or acceleration)
2) Boom
3) Slowdown/contraction
4) Recession

Question 2

What are two effects of globalisation?

Answer 2

1) Investors can invest in foreign markets

2) Disadvantage low-skilled, labour intensive industries in developed world

Question 3

What is GDP?

Answer 3

Total value of all goods and services produced domestically during calendar year

Question 4

What is PSNCR?

Answer 4

Public Sector Cash Net Requirement - difference between gov’s expenditure and revenues

If expenditure>revenue = PSNCR grows
If expenditure

Question 5

If the country is in recession, what will the public finances be like?

Answer 5

• Tax revenues weak
• Spending on unemployment rises
• PSCNR will grow

Question 6

If economy is expanding, what will the public finances be like?

Answer 6

• Tax revenues rise
• Spending on unemployment falls
• PSCNR falls

Question 7

When is the economy said to be contracting?

Answer 7

When GDP falls compared with previous quarter

Question 8

When is the economy said to be in recession?

Answer 8

Two successive quarters of declining GDP

Question 9

When is the economy said to be expanding?

Answer 9

When GDP rises compared with the previous quarter

Question 10

What happens to fixed interest securities when the economy is booming?

Answer 10

Yields increase, price decreases

Question 11

What happens to fixed interest securities when the economy is falling?

Answer 11

Yields decrease, price increases

Question 12

What happens to the prices of equities as the economy moves out of recession?

Answer 12

Generally, equities strengthen as the economy expands when interest rates remain low

Question 13

What is fiscal policy?

Answer 13

Use of government spending and taxation to influence both the both the level of demand in the economy and level of economic activity

Question 14

How does the government use fiscal policy in a recession?

Answer 14

Increase spending/cut taxation

Question 15

How does the government use fiscal policy in a boom?

Answer 15

Reduce spending/increase taxation

Question 16

How does fiscal policy affect individuals and companies?

Answer 16

• 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

Question 17

What is monetary policy

Answer 17

Attempt to stabilise economy by controlling interest rates and the supply of money

Question 18

Who sets interest rates?

Answer 18

Monetary policy committee

Question 19

What is LIBOR?

Answer 19

The rate at which banks lend to each other

Question 20

How does the Bank of England ease monetary policy?

Answer 20

Reducing short term interest rates

Question 21

How does the Bank of England tighten monetary policy?

Answer 21

Increasing short term interest rates

Question 22

What is money supply?

Answer 22

The quantity of money available within the economy to purchase goods and services

Question 23

What is M0 also known as?

Answer 23

Narrow money

Question 24

What is M4 also known as?

Answer 24

Broad money

Question 25

What are the most commonly quoted measures of money supply in the uk?

Answer 25

M0 & M4

Question 26

What is M0 (money supply measure)?

Answer 26

- 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

Question 27

If there is a growth in M0, what does this indicate?

Answer 27

Consumer spending is buoyant

Question 28

If there is a contraction in M0, what does this suggest?

Answer 28

Consumers are behaving more cautiously

Question 29

What is M4 (money supply measure)?

Answer 29

- 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

Question 30

What does a growth in m4 indicate?

Answer 30

Increased demand for loans

Question 31

What is a rapid growth in money circulating in the economy often interepreted as?

Answer 31

Build up of inflationary pressures

Question 32

What is the measure of inflation in the UK?

Answer 32

CPI

Question 33

What does CPI measure?

Answer 33

Average change from month-to-month in the prices of consumer goods and services bought by consumers within the UK

Question 34

What is the lead measure of inflation used by the ons?

Answer 34

CPIH (including owner occupiers housing costs)

Question 35

What is disinflation?

Answer 35

When there is a decrease in the rate of inflation

Question 36

What is deflation?

Answer 36

There is a decline/inflation rate becomes negative

Question 37

What effect does inflation have on cash deposits?

Answer 37

- Inflation erodes value of capital invested | - Interest rates tend to rise and fall in line with inflation

Question 38

What is a real return?

Answer 38

Return that exceeds rate of inflation

Question 39

What affect does inflation have on fixed interest securities?

Answer 39

- 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

Question 40

What effect does inflation have on equities?

Answer 40

- Rising company profits will lead to increasing dividends and/or growth in capital value of shares - Equities tend to offer real growth

Question 41

What is the main tool used by central banks to control inflation?

Answer 41

Raising or lowering of short-term interest rates

Question 42

What is falling interest rates usually a signal for?

Answer 42

That the economy will expand in the medium term as a result of lower costs of borrowing

Question 43

How will falling interest rates affect cash deposits?

Answer 43

Make cash deposits less attractive

Question 44

What is the relationship between the price of fixed interest securities and interest rateds

Answer 44

Inverse: | - Eg as interest rates increase, price of fixed interest securities decrease

Question 45

What is the effect of lower interest rates on equities?

Answer 45

Company profits are usually higher as a result of the reduced cost of borrowing and higher demand