Economics Flashcards

Question

Goals of Monetary Policy

Answer 1

1. Price Stability: - Maintain low and stable inflation. - Prevent deflation (a general decline in prices). 2. Full Employment: - Strive for a low unemployment rate consistent with a healthy economy. 3. Economic Growth: - Create an environment conducive to sustainable long-term growth. 4. Stable Financial System: - Reduce risks of financial crises and ensure smooth functioning of markets. 5. Exchange Rate Stability (for some economies): - Avoid excessive volatility in currency values, especially in trade-dependent nations.

Answer 2

The buying and selling of securities (usually government bonds or Treasury securities) is one of the central bank's primary tools to control the money supply and influence the economy. This process is part of Open Market Operations (OMO) Buying Securities: - It injects money into the economy. - The sellers (banks, financial institutions, etc.) get cash in exchange for the bonds. - This increases the money supply, making borrowing cheaper (lower interest rates) and encouraging spending and investment. Selling Securities: - It pulls money out of the economy. - Buyers give up cash in exchange for the bonds. - This decreases the money supply, making borrowing more expensive (higher interest rates) and cooling down inflation or an overheating economy.

Answer 3

QE is an expansionary monetary policy used when interest rates are already very low (or near zero) and further rate cuts are not possible or effective. The goal is to stimulate the economy by increasing liquidity. - **QE expands the central bank’s balance sheet**: - When the central bank buys securities, it records these as assets. - At the same time, the money it creates to buy them increases its liabilities (the reserves of commercial banks). Here’s how it works: 1. The central bank purchases long-term securities (like government bonds, mortgage-backed securities, etc.) from the open market. 2. This increases the reserves of commercial banks, giving them more cash to lend to businesses and consumers. 3. With more money circulating, interest rates fall, making borrowing cheaper. 4. Cheaper borrowing encourages businesses to invest and consumers to spend, boosting economic activity. **Example of QE in Action**: - After the 2008 financial crisis, the Federal Reserve undertook massive QE programs, purchasing trillions of dollars in Treasury bonds and mortgage-backed securities to stimulate the U.S. economy.

Answer 4

**QT = Central Bank Selling Securities (or letting them mature)** QT is a contractionary monetary policy used when the economy is overheating, inflation is rising too quickly, or financial bubbles are forming. The goal is to reduce liquidity in the system. - **QT shrinks the central bank’s balance sheet**: - When the central bank sells securities or allows them to mature, both assets (securities) and liabilities (reserves) decrease. Here’s how it works: 1. The central bank sells securities back into the market or lets its bond holdings mature without reinvesting. 2. This removes cash from the banking system as banks and other institutions pay for the bonds. 3. With less money circulating, interest rates rise, making borrowing more expensive. 4. Higher borrowing costs slow down spending and investment, cooling inflation and economic activity. **Example of QT in Action**: - Starting in 2017, the Federal Reserve began shrinking its balance sheet by allowing bonds to mature without reinvesting the proceeds, signaling QT after years of QE.

Answer 5

- Bank reserves increase - Interbrank lending rates decrease - Short term and long term lending rates decrease - businesses increase investment - consumers increase durable goods purchases - domestic currency depreciates, exports increase

Answer 6

- Market rates decrease - Lenders reduce short term and long term lending rates - Interbank lending rates decrease - Firms and individuas raise growth expectations

Answer 7

1. Independence: The central bank should operate without political interference to focus solely on managing inflation, as political motivations may conflict with inflation control (e.g., boosting economic activity before elections). 2. Credibility: - The central bank must follow through on its policies and maintain consistency. - Credibility influences expectations; if markets trust the bank to keep inflation in check, this expectation alone helps stabilize prices. - A central bank must reliably follow through on its stated inflation targets to be taken seriously. If markets trust the bank’s commitment to a target (e.g., 3%), inflation expectations align with this rate, helping to anchor actual inflation at that level. 3. Transparency: - The central bank should clearly communicate its policy intentions, economic indicators, and decision rationale. - Transparency in inflation targets (usually 2-3%) and policy actions helps align market expectations with central bank goals. - By regularly disclosing economic assessments and reporting on inflation targets, a central bank strengthens its credibility. Transparency helps the market understand the factors influencing policy decisions, making policy changes easier to anticipate and enhancing the bank’s effectiveness in managing inflation. 4. Inflation Targeting: - Most central banks now target inflation directly, instead of focusing solely on interest rates. - When inflation is above the target, the bank will reduce money supply to control prices; when below, it may increase money supply to stimulate demand.

Answer 8

- When people prefer holding cash over investing, even at low interest rates, monetary policy becomes ineffective in lowering rates further. This often occurs during deflation, when expansionary policies fail to stimulate growth. - Rates can’t go any lower - if they’re already at zero, cant go any more

Answer 9

- Interest Rates: Higher. - Output: Likely lower, as both policies suppress spending. - Private and Public Sector Spending: Both are reduced, likely leading to a recessionary environment. - **Implications**: Used to address high inflation but risks economic contraction. - **Effect**: Decreased economic growth and spending. - **Interest Rates**: Higher, discouraging borrowing. - **Outcome**: Both private and public sectors shrink, reducing demand and GDP.

Answer 10

- **Interest Rates**: Lower. - **Output**: Likely higher, as low rates and increased government spending stimulate economic activity. - **Private and Public Sector Spending**: Both increase, which can lead to rapid economic growth but risks inflation if overused. - **Implications**: Often used during recessions to jumpstart economic activity. 1. - **Effect**: Strong economic growth. - **Interest Rates**: Lower, encouraging borrowing and spending. - **Outcome**: Both private and public sectors grow.

Answer 11

- Interest Rates: Higher. - Output: Higher, as government spending drives demand despite higher rates. - Private Sector Spending: Lower, as high interest rates discourage private borrowing. - Public Sector Spendin*: Higher, offsetting the private sector’s reduced spending. - Implications: Can help maintain control over inflation while still boosting growth through government spending. - Effect: Government spending drives demand, but borrowing costs are higher. - Interest Rates: Higher due to tight monetary policy. - Outcome: Government spending grows as a share of GDP, while higher rates may limit private sector growth.

Answer 12

- Interest Rates: Lower. - Output**: Variable, as outcomes depend on the balance between lower private borrowing costs and reduced government spending. - Private Sector Spending**: Higher, encouraged by low borrowing costs. - Public Sector Spending**: Lower due to fiscal constraints. - Implications**: Encourages private sector-led growth without increasing government debt, useful in economies aiming to reduce fiscal deficits. - Effect**: Lower interest rates stimulate private sector growth. - Interest Rates**: Lower due to increased money supply and less government borrowing. - Outcome**: Private sector expands, while government spending declines as a share of GDP.

Answer 13

NON-cooperation and nationalism: goal of self reliance, producing domestically, low/no external trade or capital flows, state ownership of strategic industries eg) North Korea

Answer 14

Noncooperation and globalization: open to global trade, influence; state of control of key exports eg) USA & Russia Engages globally but with unilateral influence rather than cooperation

Answer 15

Cooperation & globalization: integrated globally, many trading partners, rule standardization eg) Singapore, EU, Canada Engages in global trade and cooperation with multiple nations, sometimes regionally focused (e.g., EU).

Answer 16

- Promotes international monetary cooperation and exchange stability. - Supports balanced trade growth, multilateral payment systems, and provides funds to countries facing balance of payments issues.

Answer 17

- Focuses on poverty reduction and sustainable development in developing countries. - Provides low-interest loans, interest-free credits, and grants for projects in education, health, infrastructure, and environmental management. - Comprises the International Bank for Reconstruction and Development (IBRD) and International Development Association (IDA), each with distinct roles.

Answer 18

- Oversees global trade rules to ensure smooth, predictable, and free trade. - Resolves trade disputes and enforces trade agreements, minimizing political or military conflict. - Creates a multilateral trading system through binding agreements that protect trade rights and set trade policy limits.

Answer 19

- Definition: The risk of events disrupting peaceful international relations, classified into three types: - Event Risk: Known timing but unknown outcomes (e.g., elections). - Exogenous Risk: Unexpected events (e.g., wars, uprisings). - Thematic Risk: Long-term trends with broad impact (e.g., migration, cyber risks). - Risk Classification by Velocity: - High Velocity: Immediate impact, e.g., black swan events like unexpected wars. - Medium Velocity: Gradual effect on specific sectors (e.g., industry regulations). - Low Velocity: Slow, long-term impacts, relevant to ESG factors.

Answer 20

Tax imposed on imported goods collected by government - Increase the domestic price of imports, benefiting domestic producers and the government through tariff revenue but reducing consumer surplus. - Designed to domestic manufacturing industries - Increases the domestic supply while decreasing the quantity imported. - Tarifs on imported goods

Answer 21

Limitation on the quantity of good imported 2. - Set a limit on imports, raising domestic prices and benefiting domestic producers. If import licenses are not sold, **quota rents** accrue to foreign exporters, creating a larger welfare loss for the importing country. - Limit on the amount of goods imported - You can get import licenses

Answer 22

Payments by governments to domestic exporters - Raise the price of goods in the exporting country, benefiting producers but reducing consumer surplus domestically. - Payments to domestic exporters by govt to encourage domestic exports - Helping econ growth and GDP - Exports are creating employment and econ growth, strengthen economy - Loans, cheap finance, assistance/help

Answer 23

agreement by one country to limit the quantity of goods it will export to another country

Answer 24

Example: NAFTA (North American Free Trade Agreement). Characteristics: Removes all trade barriers (tariffs, quotas) among member countries, allowing free trade between them. Free movement, with no protectionist policies. But each country applies THIER OWN policies against non member countries

Answer 25

Removes all trade barriers (tariffs, quotas) among member countries, allowing free trade between them. Free movement, with no protectionist policies. But each country applies THIER OWN policies against non member countries Also sets a common external trade policy with nonmembers. - Example: The Southern Common Market (Mercosur).

Answer 26

Removes all trade barriers (tariffs, quotas) among member countries, allowing free trade between them. Free movement, with no protectionist policies. But each country applies THIER OWN policies against non member countries Also sets a common external trade policy with nonmembers Also removing restrictions on the movement of labor

Answer 27

Removes all trade barriers (tariffs, quotas) among member countries, allowing free trade between them. Free movement, with no protectionist policies. But each country applies THIER OWN policies against non member countries Also sets a common external trade policy with nonmembers Also removing restrictions on the movement of labor Also integrates member economies through shared institutions and economic policies

Answer 28

Combines an economic union with a shared currency, allowing member states to avoid exchange rate fluctuations and reducing transaction costs for trade.