Chapter 8 - Economic Environment Flashcards
The economy is Contracting when…
Level of the GDP falls compared to the previous quarter.
The economy is in Recession when…
Two successive quarters of declining GDP.
The economy is Expanding when….
GDP rises compared to the previous quarter.
The economy is at its Peak when…
Highest point before it starts to fall again.
What happens at the expansion phase
Above average output growth and businesses experience high sales and profits.
What happens at the boom phase
Prices and inflation continue to rise and the economy begins to overheat and interest rates are increased to dampen the expansion.
What happens at the slow down phase
Output growth slows but inflation remains high, sales start to drop as consumers become more cautious and spend less. Unemployment rises and firms go out of business.
What happens at the recovery phase
Economy moves out of recession and people start to spend more as they become more optimistic. Interest rates remain low whilst profits rise.
What happens at the recession phase
Output growth is sluggish and company profits are weak, inflation and interest rates are falling.
When is the PSNCR (Public sector net cash requirement) likely to grow
If economy is in recession, tax revenues will be weak and spending on unemployment will rise
When is the PSNCR (Public sector net cash requirement) likely to reduce
If economy is expanding, tax revenues will rise and spending on unemployment will fall as more people find jobs.
How are interest rates affected by economic cycle
If economy is slowing down, interest rates will be reduced to encourage borrowing
If economy is expanding, interest rates will be increased to slow down the rate
How the economy affects Equities
Prices pick up as the economy moves out of recession
They falter in the boom as interest rates are raised to curb the expansion of the economy
Equity prices fall as the economy contracts due to higher interest rates and declining corporate earnings.
Leading indicators
These usually change before the economy as a whole changes. Stock markets are an example of a leading indicator and stock market indices usually improve before the economy as a whole does so
Coincident Indicators
These indicators change at approximately the same time as the economy as a whole and so provide information about the current state of the economy. GDP, industrial production and retail sales all use these indicators
Lagging indicators
These usually change after the economy does. Unemployment is an example of a lagging indicator as employment only tends to increase a few quarters after an upturn in the economy.
Balance of payments - Receipt
This represents the sterling flowing into the country or any transaction that requires the exchange of foreign currency for sterling.
Balance of payments - Payment
This represents the sterling flowing out of the country or any transaction that requires the exchange of foreign currency for sterling.
Current Account
The current account consists of transaction in goods (visible trade) and services (invisible trade)
Visible - oil, agricultural, raw materials, computers, white goods
Invisible - exports and imports of services such as international transport, travel, tourism, financial and business services
Capital Account
The capital account of a country’s balance of payments records all movement of money into and out of the country for investment. This may be an investment in real assets (such as land and buildings) or financial assets (shares, bonds, loans)
Foreign currencies
Gold
International Monetary Fund (IMF) special drawing rights (SDRs)
UK reserve tranche position at the IMF
Value of currency
If there is a surplus on the current account, a country exports more goods and services than it imports - then buyers have to acquire the currency to pay for the goods.
This adds to the country’s foreign reserves and strengthens the currency.
A current account deficit implies the needs to sell the local currency to acquire foreign goods. This would lead to a change in the demand for that currency.
Which would cause a change in exchange rate with the currency weakening in value.
Strengthening of a currency (Rise)
Exports become more expensive and so, fewer goods are demanded
Imports become cheaper and demand increases
Aggregate demand falls, leads to lower growth
Inflation falls because;
- the effect of cheaper prices for imported goods
- lower aggregate demand
- less demand-pull inflation
Devaluation of a currency (fall)
More competitive exports, increasing demand for goods
More expensive imports, reducing demand for those goods
Higher economic growth and rising aggregate demand
Rising inflation
Improvement in the current account balance of payments
Movements in the pound affect domestic shares
Profitability of exports
Rise in the pound - Reduces
Fall in the pound - Increases
Share price of major exporters
Rise in the pound - Reduces
Fall in the pound - Increases
Value of profits earned overseas by UK companies
Rise in the pound - Reduces
Fall in the pound - Increases
What is Fiscal Policy?
Fiscal policy is the use of government spending and taxation to influence both the level of demand in the economy and level of economic activity
What is Monetary Policy?
Monetary policy attempts to stabilise the economy by controlling interest rates and the supply of money.
What is Money Supply?
Money supply is the quantity of money available within the economy to purchase goods and services
M0 Narrow money is
Notes and coins in circulation
Banks operational deposits with the Bank of England
M0 is also known as narrow money and is an indicator of consumer spending and retail sales
Growth in M0 indicates consumer spending is buoyant
Contraction in M0 suggests that consumers are behaving cautiously
M4 Broad Money is
Includes all M0 (coins, notes)
Instant access accounts, deposits and lending activities
Cost-push inflation
If firms face increased costs and inelastic demand for their output, the likelihood is that these rising costs will be passed on to the end consumer
Consumers will, in turn, demand higher wages from firms causing a wage-price to develop
Demand- pull inflation
When the economy is operating beyond its full employment level of output, prices are pulled up as a result of inflationary gap emerging.
This excess demand can often stem from the optimism that accompanies rising asset prices but has often resulted from politically inspired tax cuts.
What is Disinflation
Occurs when there is a decrease in the rate of inflation.
What is Deflation
Deflation is the opposite of inflation and occurs as prices decline over time and the inflation rate becomes negative.
What is Stagflation?
Stagflation is a combination of stagnant growth and inflation.
