Chapter 2: Economic Environment Flashcards
State controlled economies
State decides what is produced and how it’s distributed. Also known as planned economy (production is planned) or command economy.
Advantage is low levels of inequality and unemployment.
Market economies
Forces of supply and demand determine how resources are allocated.
Businesses produce goods and services to meet the demand from consumers. The interaction of demand from consumers and supply from businesses in the market will determine the market-clearing price. This is the price that reflects the balance between what consumers will willingly pay for goods and services and what suppliers will accept for them. Oversupply = low price and opposite for undersupply.
Mixed economies
Combines market economy with state control. In mixed economies governments will provide a welfare system to support the unemployed, the infirm and the elderly, in tandem with the market-driven aspects of the economy.
Governments raise finance by:
- collecting taxes
- raising money through borrowing
Open economies
Economic relationships between outside countries. Few barriers to trade or controls over foreign exchange.
Protectionism
When a country prevents other countries from trading freely with it in order to preserve its domestic market.
World trade organisation (WTO) exists to promote the growth of free trade between economies.
Macroeconomic objectives
- Full employment
- Economic growth
- Low inflation
- Balance of payments equilibrium
Stages of economic cycle
Begins with the PEAK which drops to the CONTRACTION. Hits a TROUGH at the bottom. Rises with is EXPANSION and then PEAKS again.
Peak - GDP at highest point
Contraction - GDP declines as economic activity slows
Trough - GDP at lowest point
Expansion - economic activity picks up and GDP begins growing again
Fiscal policy
An action by the government to spend money, or to collect money in taxes, with the purpose of influencing the condition of the economy.
Tools to influence the level of spending in economy
- The budget - the government budget is a statement of public income and expenditure over a period of one year. There will be a balanced budget where income equals expenditure. A deficit budget where expenditure exceeds income or a surplus budget where income exceeds expenditure. With a budget deficit the government must borrow to make up the difference. This is known as public sector borrowing requirement (PSBR).
- Taxation - gov can influence the level of spending in the economy. If gov reduce tax and keep its own spending constant it would mean that firms and households would have more disposable income.
Implications of fiscal policy for business
- Planning
- Costs
Monetary policy
The regulation of the economy through control of the monetary system by operating on such variables as the money supply, the level of interest rates and the conditions for the availability of credit.
Monetary policy: money supply
The government can target the stock of money as an economic tool. They may decide to impose a ‘credit squeeze’ and restrict credit lending to control levels of spending and reduce inflation. They may also impose reserve requirements on banks.
Monetary policy: interest rates
An increase in interest rates is thought to discourage spending in the economy and thereby reduce the level of aggregate spending.
The role of central banks
- Act as banker to banking system by accepting deposits from and lending to commercial banks
- Act as bank to government
- Manage national debt
- Regulate domestic banking system
- Set official short term rate of interest
- Control money supply
- Issue notes and coins
- Hold nations gold and foreign currency reserves
Bank of England (BoE)
UK central bank.
Two core purposes:
1. Monetary stability
2. Financial stability
Monetary stability
Interest rate decisions are taken by the Monetary Policy Committee (MPC). Made up of 9 members.
MPC
Focus is to ensure that inflation is kept within a government set range, set each year by the chancellor of the exchequer, to support the governments economic objectives, including those for growth and employment. The MPC does this by setting the base rate which is otherwise known as the ‘official bank rate’.
Quantitative easing (QE)
Inject cash directly into the economy to stimulate demand and return inflation to target.
Involves the central bank creating money, which it then used to buy assets such as government bonds and high quality debt from private companies, resulting in more money in the wider economy.
The central bank buys assets from private sector institutions and credits the sellers bank account so the seller has more money in their account, while the central bank holds assets as part of its reserves. The objective is to move money out in the wider economy.
QE: injecting money into economy
- Seller of bonds ends up with more money and may spend it, which will help boost growth
- They may buy others assets instead and in doing so boosts prices and provide liquidity to other sectors of the economy - spend more
- Buying assets means higher asset prices and lower yields which brings down cost of borrowing for businesses and households - spend more
Financial stability
Central banks preserve financial stability which maintains 3 vital functions:
- Provides the main mechanism for paying for goods, services and financial assets
- Intermediates between savers and borrowers, and channels savings into investments via debt and equity instruments
- Insures against and disperses risk
Financial policy committee (FPC)
Tasked with monitoring the stability and resilience of the UK financial system and using it powers to tackle those risks. It also gives direction and recommendations to PRA and FCA.
It has two key policy levers:
1. Recommendation - ‘comply or explain’
2. Directions - to PRA and FCA
Federal reserve (Fed)
Comprises 12 regional federal reserve banks, each do which monitors the activities of and provides liquidity to the banks in the region.
Governed by a seven strong board appointed by the president of the US. 5 presidents of the 12 Feds makes up the Federal open market market committee (FOMC). Chairman (appointed by president) takes responsibility for the committees decisions which are directed towards its statutory duty of promoting price stability and sustainable economic growth.
European Central Bank (ECB)
Based in Frankfurt. Principally responsible for setting monetary policy for the entire Eurozone, with the objective of maintaining internal price stability.
Sets policy through its president and council.
The single supervisory mechanism (SSM) is a new framework for banking supervision. Main aims:
1. Ensure safety and soundness of European banking system
2. Increase financial integration and stability in Europe
What is inflation:
The persistent increase in the general level of prices.
This is due to excess demand in the economy, scarcity of resources and key workers, or rapidly increasing government spending. Most governments seek to control inflation at 2-3%.
