chapter 15- the financial sector

Question 1

what is the money supply

Answer 1

the money supply refers to the total volume of the currency held by the public at a particular point in time. in the eurozone in June 2022, this amounted to €15.85 trillion

Question 2

what is money supply as defined by the ECB

Answer 2

-M1 (narrow money supply) - currency i.e. notes and coins, plus balances that can immediately be changed into currency or used for cashless payments i.e. overnight deposits

-M2 (intermediate money supply) - M1 + deposits with an agreed maturity up to two years and deposits redeemable at a period of notice up to three months

-M3 - (broad money supply) - M2 + repurchase agreements + money market fund shares/units + debt securities up to 2 years

Question 3

how banks create credit ?

the 4 steps

Answer 3

customers don’t demand all their cash to be available all the time for their banks. Banks know tis, and use some of our cash deposits in order to create loan to give to other customers , making a profit from them

1.commercial banks accept cash deposits from their customers eg say €100 for safekeeping

2.these banks know from experience that their customers will only demand back a small amount of these deposits in cash - say 10% because of their use of cheques as an acceptable method of payment

the reserve ratio is the percentage of deposits a financial institution must keep in cash form( eg in a safe ) to meet customer’s demands for cash. it is also referred to as the reserve requirement

3. so they now have surplus cash with which to give/cash loans €90 cash
4. the amount of loans they give is related to, but in excess of their cash deposits and is based on their reserve ratio

Question 4

implications of increasing the availability of credit - positive

Answer 4

1. increased national income - by creating credit, bank are injecting money into the economy

2.increased employment - if banks increase mortgage lending, this would stimulate employment in the construction industry

3. increased government tax revenue - by stimulating demand for goods and services, there would be an increase in government current revenue from direct taxes on employment and on spending
4. increased investment - the funds for investment are often borrowed eg a business expansion or the opening of a new business

Question 5

implications of increasing the availability of credit - negative

Answer 5

1.poor lending decisions - the global financial crisis of 2008 was caused by banks after having lent too much money into the property market

2. inflation - if banks create too much credit, this can caused inflation as it results in an increase in demand
3. increased imports - the provision of credit can result in increased spending on imports and money leave the country as a result

4.the business cycle - banks tend to lend too much during a period of economic growth, which can result in overheating of an economy

5. overdependence on credit- eg the car industry and property markets are heavily dependant on the continued flow of credit from financial institutions - happening in Ireland now

Question 6

factors that impact the level of interest rates

Answer 6

1. monetary policy around inflation/economic growth - during periods of economic growth that result in high inflation, the ECB increases its interest rate. this in turn, increases the interest rates that commercial banks charge borrowers and pay savers
2. highly concentrated market - due to the lack of competition in the Irish mortgage market, mortgage interest rates in Ireland are higher than in many other eurozone countries. Irish people have been slow to switch despite savings being available - lots of paperwork, some solicitors fees etc… but we are increasingly moving mortgage providers in Ireland.

3.decrease in money supply
4.credit crunch - economic downturn
5. type of loan

Question 7

what are interest rates

Answer 7

the interest rate is the price expressed at a percentage, that borrowers pay for using saver’s funds.it is also the price that savers get for offering their funds to borrowers to rent.

the nominal interest rate is the interest rate unadjusted for inflation - so the figure itself.
eg if interest rates were 4% and you saved €100, then you would have €104 at the end of the year

the real interest rate is the interest rate adjusted for inflation , the interest rate minus the inflation rate

Question 8

what are the economic effects of rising interest rates on the Irish economy

Answer 8

1. borrowing discouraged
   2.savings encouraged
   3.increased mortgage repayments
   4.increased cost of servicing the national debt
2. increased costs of production/ reduced competitiveness
3. disincentive to invest
4. economic growth hindered
   8.taxation revenue effects
5. increased unemployment

Question 9

the role and effectiveness of current financial institutions in the operation of financial markets

Answer 9

1. to make credit available
2. enable money to smoothly in time
3. to pool risk

Question 10

what is the role and effectiveness of the central bank of Ireland

Answer 10

1. prints legal tender
2. financial regulator
3. the bankers bank
4. maintain price stability
5. governments bank