Economic Environment Flashcards
Describe the economic / business cycle
An economic / business cycle can be divided into four main phases (although the economy does not always go through all phases):
1. Recovery, followed by expansion or acceleration of economic growth
2. Boom
3. Slowdown or contraction
4. Recession
Factors such as GDP, interest rates, total employment and consumer spending can help to determine the current stage of the economic cycle.
Understanding the economic cycle can help investors determine when to make investments / when to pull out as it has a direct impact on stocks and bonds as well as profits and corporate earnings.
Describe the recovery / expansion phase of the business cycle
- The economy experiences relatively rapid growth
- Interest rates tend to be low – cost of money is cheap
- Production increases
- Economic indicators associated with growth such as employment / wages, corporate profits / output, demand and the supply of goods / services tend to show sustained uptrends
- Flow of money through economy remains healthy
- The increase in the money supply may cause inflation to pick up during the economic growth phase
Describe the boom / peak phase of the business cycle
- Growth hits maximum rate
- Prices and economic indicators stabilise for short period before reversing to downside
- Peak growth typically creates imbalances in the economy that need to be corrected
- As a result, businesses may start to revaluate their budgets and spending
Describe the slowdown / contraction phase of the business cycle
- A correction occurs when growth slows
- Employment falls
- Prices stagnate
- Demand falls and businesses may not immediately adjust production levels leading to oversaturated markets with surplus supply, worsening downward movement in prices
- During this stage, economic indications that were on an upward course during expansion begin to deteriorate
- If contraction continues, may spiral into depression
Describe the trough / recession phase of the business cycle
- Economy hits a low point
- Supply and demand scraping bottom before growth begins to recover
- Painful moment for economy – widespread negative impact from stagnating spending and income
- However, provides opportunity for individuals and businesses to reconfigure their finances in anticipation of a recovery
How does the business cycle affect investment
Fixed interest:
- Attractive when inflation and interest rates are low and falling
- Price of fixed interest falls when economy is booming
Equities:
- Generally, price of equities rise and fall with economy
Describe fiscal policy
Use of government spending and taxation to influence economic activity (e.g., cut taxes to stimulate demand)
Describe monetary policy
Attempt to stabilise economy through interest rates and money supply
Explain what M0 and M4 is?
Measures of money supply
M0 - narrow money - notes and coins in circulation plus bank’s operational deposits with the Bank of England
M4 - broad money - notes and coins in circulation plus bank accounts
What is disinflation?
Decrease in rate of inflation - prices still rising but at a slowing rate
What is stagflation?
Combination of stagnant growth and inflation
Effects of inflation on investments
Cash: variable rates tend to rise and fall in line with inflation, ‘real’ interest takes account of inflation
Fixed interest: inflation particularly significant, income is fixed whether prices rise or fall, index-linked gilts offer long term inflation protection
Equities: seen as a good hedge against inflation, efficient companies increase profits at least in line with inflation, leading to increased dividends per share price
How to increase money supply?
- Reduce interest rates
- Quantitative easing - creating money to buy gilts and corp bonds to bring liquidity to financial markets and increase banks’ lending capacity
Current account vs capital account
SEE BOOKLET FOR NOTES
Visible trade vs invisible trade
Visible trade = transactions in goods (e.g., oil, agricultural products)
Invisible trade = transactions in services (e.g., transport, travel, tourism)
