Chapter 2 The Economic Environment

Question 1

Define a state-controlled Economy

Answer 1

A state which controls the flow and supply of resources. What is produced and how it is distributed. Example would be USSR.

Question 2

Define a Market Economy

Answer 2

A state which has limited involvement in the economy, with the market operating on a supply and demand model. Example would be Switzerland.

Question 3

What is Protectionism?

Answer 3

The process of preventing other countries from trading freely with it in order to preserve its domestic market.

Question 3

Define a Mixed Economy

Answer 3

A mixed economy is an economy where market economic policies are mixed with some elements of state control. Example would be UK.

Question 3

Define an Open Economy

Answer 3

Open Economy essentially relates to a country’s economic relationship with outside countries. Very few barriers to trade or controls over FX. Example would be EU or WTO.

Question 4

What is the role of the government in the Economy?

Answer 4

To manage the economy through taxation and through economic and monetary policy.

Question 5

What is the difference between fiscal and monetary policy?

Answer 5

Fiscal policy involves making adjustments using government spending and taxation whereas monetary policy involves making adjustments to interest rates and the money supply.

Question 6

What is Macroeconomic policy?

Answer 6

The process in which the management of the economy by the government influences the performance behaviour of the economy.

Question 7

Name some Macroeconomic objectives.

Answer 7

Full employment, Economic growth, Low inflation, Balance of payments equilibrium.

Question 8

Name the 7 stages of the Economic cycle.

Answer 8

Peak - Contraction - Trough - Expansion - Growth - Trend - Peak

Question 9

Define Peak in terms of the economic cycle.

Answer 9

GDP at its highest point.

Question 10

Define Contraction in terms of the economic cycle.

Answer 10

The period over which GDP declines as economic activity slows. When there are two consecutive Q’s of declining GDP, economists refer to this as a recession.

Question 11

Define Trough in terms of the economic cycle.

Answer 11

GDP at its lowest point. The contraction phase is over.

Question 12

Define Expansion in terms of the economic cycle.

Answer 12

Economic activity picks up and GDP begins growing once again. Usually characterised by a moderate increase in GDP.

Question 13

How do higher interest rates effect the society/market around them? (Negative)

Answer 13

Consumers are encouraged to save.
Mortgage payments rise, leaving less disposable income for homeowners.
Higher cost of credit deters borrowing and in-turn spending.
Level of corporate investments decline due to higher borrowing costs.
Corporate sector may lose confidence in the economy and become pessimistic about future prospects.

Question 14

How do higher interest rates effect the society/market around them? (Others)

Answer 14

Higher interest means greater interest income for savers - spending may go up.
Demands for higher wages arise from need to make mortgage payments.
Higher interest rates attract capital inflows. Leads to appreciate in FX rate, meaning imports are cheaper and more attractive.

Question 15

Name 7 of the 11 Roles of Central Banks

Answer 15

Acting as a banker to the banking system
Acting as a banker to the govt
Managing the national debt
Regulating the domestic banking system
Acting as a lender of last resort in financial crises
Setting the official short-term rate of interest
Controlling the money supply
Issuing notes and coins
Holding the nation’s gold and foreign currency reserves
Influencing the value of a nation’s currency through intervention in the currency markets (etc…)
Proving a depositors’ protection scheme for bank deposits.

Question 16

Name the Bank of England’s two core purposes.

Answer 16

Monetary Stability (2% CPI Target)

Financial Stability (Reducing threats to system as a whole)

Question 17

Who are the BoE’s interest rate decisions taken by?

Answer 17

The Monetary Policy Committee (MPC)

Question 18

What are the three vital functions for maintaining financial stability?

Answer 18

Providing the main mechanism for paying for goods, services and financial assets
Intermediating between savers and borrowers, and channelling savings into investment via debt and equity instruments
Insuring against and dispersing risk

Question 19

What is the 2011-establish BoE committee and who does it give direction to / recommendations?

Answer 19

The Financial Policy Committee (FPC), giving direction to the PRA and FCA.

Question 20

Who manages the national debt?

Answer 20

The debt management office (DMO)

Question 21

Who protects depositors?

Answer 21

The financial services compensation scheme (FSCS)

Question 22

How is GDP calculated?

Answer 22

Consumer Spending + Gov’t spending + Investment + Exports - Imports = GDP

Question 23

How often is GDP calculated?

Answer 23

Quarterly

Question 24

What is the balance of payments?

Answer 24

The balance of payments is a summary of all the transactions between the UK and the rest of the world.

Question 25

What is a budget deficit?

Answer 25

The shortfall between what the gov’t spends and how much it receives in taxes.

Question 26

What is the PSCNR?

Answer 26

The public sector net cash requirement.

Question 27

Name 3 of the 5 FX central bank strategy’s

Answer 27

Fixed-Rate Spending - (Exchange rate tied to a particular currency - Bank intervenes)
Floating-Rate System - (Supply + Demand)
Target Zone - (Lower and Upper band limit)
Crawling Peg - (Upper and lower wide bands, used to move from fixed rate)
Managed Float - (Exchange rate largely floating with occasional input from bank)