Chapter 5 - Environmental Influences Flashcards
Main interests of the central bank
- Monetary, interest rate and inflation policy
- Banking regulation
- Implementation of government borrowing
- Performance and integrity of financial markets
- Intervention in currency markets
- Printing and minting of notes and coins
- Taxation
Main economic variable controlled by the money supply
Inflation
Open market operations (OMOs)
Central bank buying and selling of bills
Non-market controls used by central banks
- Setting minimum liquid reserve ratios
- Setting interest rate ceilings for bank deposits
- Issuing directives regarding the types of lending to be undertaken
Quantitative easing
Monetary policy used to increase the supply of money
Usually involves both a direct increase in money supply (by purchasing financial assets from banks and other financial institutions) and a knock-on effect from the fractional reserve system (e.g. changes to the reserve requirements for banks)
Fractional reserve system
Refers to funds being received by banks and loaned on to other customers
Bank reserves are only a fraction of the quantity of deposits in the banks
Forward guidance
Guidance by central bank on how it believes monetary policy will change in the future
Main investor classes
- Private individuals (“households”)
- Managers of short-term and long-term mass savings products (“financial intermediaries”)
- Corporates
- Foreign investors
Investor classes mainly differ in respect to
- Time horizons
- Appetite for risk
- Taxation position
Households
Diversification is a key consideration (leads to the need for financial intermediaries)
- Small amounts available to invest
- Much of wealth tied in house
Financial intermediaries: Broad definition
Channels resources between lenders and borrowers
Financial intermediaries: Advantages and disadvantages
Advantages:
- Pooling of resources from small investors enables lending to large borrowers
- Diversification from lending to many borrowers allows acceptance of loans which individuals might deem too risky
- Expertise from large volumes of business
Disadvantages:
- Additional layer of cost
- Products offered might need meet requirements of investors
- Products might be inflexible
- Loss of control over investment choice
Businesses
Typically need to raise money to finance investment in real assets
Objectives in issuing securities:
- Get best possible price
- Market at lowest possible cost
- Issuing securities that best meet their requirements
Investment banking firms
- Advise issuing firms on prices to charge
- Handle marketing of securities
- Protect own reputation by checking and certifying quality of information offered
- Innovate security design and packaging to stimulate demand
Governments
Are not major investors.
Typically borrow to finance expenditure (By exploiting they creditworthiness)
Main types of securities issued by governments (2)
- Treasury bills
- Government bonds
Sources of finance for governments (other than borrowing)
Taxation
Also:
- Sale of public assets
- Profits from nationalised industries
- Printing of money
Main forms of government policy
- Monetary Policy
- Fiscal Policy
- National debt management policy
- Exchange rate policy
- Price and incomes policy
Monetary policy
The control of some measures of the money supply and/or the level and structure of interest rates
Fiscal policy
Decisions on the level and structure o taxation and government expenditure
National deb management policy
The manipulation of the outstanding stock of government debt instruments held by the domestic private sector
Exchange rate policy
Directed towards achieving some target for the exchange rate of the domestic currency in terms of foreign currencies
Prices and incomes policy
Aimed at influencing the rates of wage and price inflation
Other forms of government policy: Taxation
Policy regarding overall level and distribution of taxes
Other forms of government policy: Labour policy
Sets the background for the flexibility of labour and the bargaining power of organised labour
Major economic policy objectives
- Unemployment (low)
- Inflation (low and stable)
- Balance of payments (at a level that does not constrain the achievement of other objectives)
- Economic growth (high and stable)
Effects of interest rates on the domestic economy (Personal sector)
- Increase in mortgage repayments => lower disposable income and personal sector expenditure
- Higher rates on credit might also encourage higher levels of saving
Effects of interest rates on the domestic economy (Business sector)
- Likely detrimental since capital investment and economic growth prospects will be reduced
- Higher levels of interest payments on outstanding debt will reduce corporate profitability
Effects of interest rates on the balance of payments
An increase in domestic interest rates is likely to attract an inflow of foreign investment funds and may also encourage the repatriation of domestic funds held overseas
