Chapter Three Flashcards
What does the nominal interest rate compensate for?
The effect of expected inflation so where inflation is in line with expectations there is no wealth transfer between borrower and lender
What happens when inflation is higher than expected?
The nominal interest rate will undercompensate for this leading to a redistribution of wealth from lender to borrower and consequently from the old to the young
When can higher inflation disrupt investment planning?
If anticipated real returns fall and higher inflation tends to be more variable and uncertain
What is true if unemployment was at its natural level?
Theory states that inflation would be stable and not accelerating
What would reduce the size of the public sector net cash requirement?
Increased corporate tax will increase government revenue and other things being equal reduce the deficit of government expenditure and hence borrowing requirements
A country is said to be in internal and external balance when?
AD is at full employment and the current account of the balance of payments balance.
What do external and internal balances refer to?
International trade flows whereas internal balance refers to full employment
If fixed investment is very sensitive to changes in interest rates, the most effective method of stimulating the economy would be to?
Increase the money supply as it would reduce interest rates, making private sector investment more attractive to UK firms
Explain the fractional reserve banking system?
It gives rise to the potential money multiplier. The monetary base is the currency supplied by the bank to the commercial banks and private sector. The money multiplier is the extent to which the money supply is a multiple of the monetary base
What are key determinants of the size of the multiplier?
The cash reserve ratio of commercial banks, and the private sector’s preferred ratio of cash to bank deposits. The lower these ratios are, the larger the money multiplier will be
Why is it called fractional reserve banking?
As only a small proportion of the sterling liabilities are held as cash assets. Banks create money because of fractional reserve banking. If only a small proportion of new deposits have to be retained as cash reserves, this facilitates the expansion of more loans
Describe the balanced budget multipler
It will generate an increase in overall national income even though government spending and revenue are balanced.
Forward rate
Forward = spot x (1+rv)/(1+rf)
Is a weakening currency good for exporters?
Yes as it makes their products cheaper in foreign currency terms
How are spot and forward rates linked?
They are linked by interest rate parity
What is M0?
It is the narrowest measure of the money supply. M0 was the BoE’s main narrow money measure and comprised sterling notes and coins in circulation outside the Bank, together with banks’ operation deposits with BoE.
What is M2?
M2 is notes and coints plus all retail deposits held by the non-bank private sector
What is M4?
Includes notes and coins, deposits, CDs, repos and securities with a maturity of less than five years held by the nonbank private sector
What is the Taylor rule?
It suggests that a 1% change in inflation should be countered by a greater than 1% change in interest rates in the same direction.
What does the Taylor rule specify?
The relationship between short-term interest rates, inflation relative to target inflation, and GDP relative to full employment output
What is the aim of the Taylor rule?
To set rates that will stabilise the economy in the short term and still maintain long-term growth. It is intended to reduce uncertainty about economic policy and enhance policy credibility
What does the debt deflation or credit cycle theory suggest?
That the financial sector causes cyclical changes in the economy as a result of its attitude towards credit availability
What is an optimal currency area?
An optimal currency area is a geographical region in which overall economic efficiency will be maximised through the use of a single currency
What is the minimum level of common equity Tier 1 capital permitted by Basel III?
4.5%. European regulators require a mnimum level of liquidity relative to total liabilites.
What did Basel III introduce?
A new set of liquidity coverage rules that ensure a bank has adequate stock of high quality liquid assets that can be converted into cash easily and immediately in private markets
What is common equity tier 1?
The highest quality of regulatory capital, as it absorbs losses immediately when they occur.
What does CET1 measure?
The CET1 ratio measures a bank’s capital against its assets
What is helicopter money?
The printing and distribution of money to the population, either directly or through infrastructure investments or tax cuts
How does helicopter money work?
It is a form of monetary finance whereby the central bank finances fiscal stimulus through money creation.
How do banks provide helicopter money?
The bank provides money to the government which can involve a direct transfer to the government’s account, buying government debt and direct payments to the general population.
What socio-economic trends affect a country’s macroeconomic policy?
The role of an ageing population. This adds extra demands to the health service and pension provision in the UK
What is another major macro consideration?
Climate change and sustainable development for poorer nations, with an integrated approach to a low-carbon, high-growth transformation of the economy
