Financial Markets and Monetary Policy Flashcards
1
Q
What are the 4 functions of money?
A
A medium of exchange
A measure of value
A store of value
A method of deferred payment.
2
Q
Without Money how were transactions conducted?
A
Through bartering.
3
Q
What was Bartering?
A
Goods and services were traded with other goods and services, but people didn’t get exactly what they wanted or needed. The goods traded were not exactly the same value.
4
Q
Therefore how does A medium of exchange allow money and economy to function?
A
Exchange could only happen if their was a double coincidence of wants i.e both parties have to want he good the other party offers. Using money eliminates this problem.
5
Q
What does a measure of value mean ?
A
Money provides a means to measure the relative values of different goods and services e.g piece of jewellery might be considered more valuable than a table because of the price.
6
Q
What does a Store of value mean?
A
Money has to hold its value to be used for payment. It can be kept for a long time without expiring.
7
Q
What is the argument against store of value?
A
Some have argued that inflation, by reducing the value of money, diminishes the ability of money to function as store of value.
8
Q
What does Money as a method of deferred payment mean?
A
Money can allow for debts to be created. People can therefore pay for things without having money in the present, and can pay for it later.
9
Q
What are 6 characteristics of Money?
A
Durability Portability Divisibility Unifromity Limited supply Acceptability
10
Q
What does it mean if money is durable?
A
Money must be able to withstand the wear and tear of many people using it.
11
Q
What does it mean if money is portable?
A
Money is easy to carry around
12
Q
What does it mean if money is Divisible?
A
Money must be easily divided into small parts so that people can purchase goods and services at any price.
13
Q
What does it mean if Money has Uniformity?
A
Any two identical units of money must be uniform or the same in the terms of what they will buy.
14
Q
What does it mean if money is in Limited supply?
A
To be useful, money must have limited supply or it becomes worthless.
15
Q
What does it mean if money is acceptable?
A
Money must be widely accepted as a medium of exchange.
16
Q
What does Liquid assets mean?
A
Something you own that can quickly and simply be converted into cash where retaining its market value.
17
Q
What are the 3 types of money?
A
1) Notes and Coins
2) Deposits
3) Near money
18
Q
Why are Deposits a type of money?
A
It can be easily be converted into cash from banks as they are highly liquid.
19
Q
What is Near money?
A
Non cash assets which can be easily converted into money e.g. bonds
20
Q
What is the Money Supply?
A
The total amount of money circulating in the economy. it includes cash and money held in saving accounts.
21
Q
What is narrow money?
A
is physical currency (notes and coins), as well as deposits and liquid assets in the central bank.
22
Q
What is Broad money?
A
Broad money includes the entire money supply.narrow money + less liquid instruments (securities, bank deposits)
23
Q
What is a financial market?
A
financial markets are where traders buy and sell assets
24
Q
What are 3 types of financial markets?
A
Money markets Capital markets Foreign exchange market
25
What is the money market?
liquid assets are traded. It is used to borrow and lend money in the short term. e.g. bonds
26
What is a capital market?
are the markets where securities such as shares and bonds are issued to raise medium to long-term financing
27
What is a Foreign exchange market
is a market where currencies are traded, mainly by international banks
28
How may firms raise money? 3 ways
- issuing shares
- issuing corporate bonds
- borrowing from a bank
29
What is the role of financial markets in the wider economy?
Make money available to those who want to spend more than their income using the savings of those who don't currently want to spend.
30
What is debt?
Borrowed money that must be payed back (e.g. bond)
31
What is equity?
the value of the interest of an owner or partial owner in an asset e.g. shares
32
What is a current account?
Cash can be withdrawn immediately, so these perform a medium of exchange and store of value.
33
What is Saving,term, time deposits?
Can't withdraw cash, immediately, so this type of money doesn't act as a medium of exchange and store of value.
34
What are 3 reasons you charge interest?
1) To account for inflation 2) To cover admin of the loan To reward the lender for taking a risk of his/her money.
35
Why is there an inverse relationship between market interest rates and bond prices?
A rise in interest rates means that savers will put their money in the bank as opposed to purchasing bonds as interest may be higher and the risk is lower. This represents a fall in demand for bonds and therefore a fall in price.
36
What is issue of shares?
A share in the business is sold to an individual or another business ( known as equity finance), this money is used to purchase new assets.
37
What is Rights issue?
When a company issues more shares.
38
Issues of shares is only applicable to what types of company?
Private Company (LTD) Public company ( PLC)
39
What is a Private limited company?
Shares are not traded on the stock market
40
What is a Public limited company?
Shares are traded on the stock market.
41
What is an advantage of issuing shares?
Some businesses can raise large sums of money.
42
What is a disadvantage of issuing shares?
Risky for the shareholder- the investment may be lost if the business fails.
43
Give 2 examples of Sources of long term fiances?
Long term loans
Retained profit.
44
What is a commercial bank?
A commercial bank manages deposits, cheques and savings accounts for individuals and firms. They can make loans using the money saved with them.e.g llyords
45
What are assets?
What is owned by a bank
46
What are examples of assets?
Cash, Securites (bonds) and loans
47
What are liabilites?
all the firms debts
48
What are examples of liabilities?
Money to bond holders and to Bond holders
49
In the balance sheet what must balance?
Assests = liabilities + capital
50
What is capital in a balance sheet
it is what is left over when assets have been sold and liabilities have been paid. It is apart of the liabilites section which comprise of shareholder funds and retained profit ( divendends). (these do not belong to the comemrical bank, they belong to shareholders.
51
Why does it make sense that the balance sheet is called the balance sheet?
If what the bank owes is more than what it is owned this is not sustainable
52
What is the structure of commerical banks before lending and what are reserves?
Reserve requirements are the amount of funds that a bank holds in reserve at the bank of england to ensure that it is able to meet liabilities in case of sudden withdrawals. ( deposits from liabilites).
53
What is an important think about reserves?
Reserves can only be lent between namks not to customers
54
If you deposit your money in a commerical bank and you want it back how does this work?
If depositers want their money bank the commerical bank can take the money out from reserves at the bank of england and fufil needs of depositers?
55
What is the structure of a commerical bank after lending?
56
Explain the structure of the commerical banks after lending?
When the bank makes a loan to a customer that adds to the liabilites because they are creating a deposit for the lender and adds to asset because when you take out a loan and spend it, it still goes to the bank
57
What are the main functions of commercial banks?
to accept savings
- to lend
- to allow payments between people/firms
58
What is an investment bank?
Investment banks facilitate the trade of stocks, bonds and other forms of investment e.g. j.p morgan
59
What are the main functions of investment banks?
offer advice of raising finance, mergers etc
60
What are the 3 objectives of commerical banks?
Liquidity, security, profitability
61
What does Profitbability mran?
Banks need to earn profits to pay their depositors interest, wages and general expenses and shareholders. Holding a lot of funds in cash means profitability is limited.
62
What are some of the conflicts between the objectives of commercial banks?
Commerical banks might take more risk by offering unsecured loans ( e.g. those with a bad financial history) meaning they can charge a higher interest.
63
Banks being profitable might lead to bank failure, what is a deeper consequence to this?
There might be systemic risk, if one bank fails other banks might fail
64
Due to bank failure banks need to manage their profit objective with Liquidity and Security? How can securtiy be an objective?
Holding more cash and reserves at the Bank of england and lending to intermidate banks to ensure liqudity to avoid bank failure. Although this is less profitable ( each reserves at BOE you will only get a bank rate) This allows firms to still meet liabilities.
65
Why is security another objective?
To manage risk to avoid insolvency ( cannot pay debts Liabilitites \> assets). This means offering secure loans ( safe lenders with good financial history) , which are not profitable as you cannot charge high interest. This means they have enough capital to pay shareholders if some loans go bad.
66
How do banks create credit?
When a loan is granted, the bank creates a deposit in the customer's account. The loan is an asset for the bank but the deposit is a liability (because if the customer wanted to withdraw it the bank would have to pay)
67
What is a bond?
Simply loaning money to the issuer ( bank) for a fixed period of time. The issuer ( bank) will give you IOU ( I owe unto) certificate, to prove that you have been given a bond. At the end of that period, the value of the bond is repaid, with interest
68
What is the primary market?
issuers issue bonds
69
What is the secondary market?
Where you can buy bonds from other people who have been issued.
70
What does the term maturity mean in relation to bonds?
The time at which the bond is redeemed by the issuer paying the value of the bond
71
What is another word for bonds?
Gilts
72
How do you calculate bond yield?
Interest on bond / market price of bond X 100
73
Consider a 10 year govt bond issued in 2016, with a nominal value of £5000 and payes interest of £200, What is the percentage yield of the bond?
200/ 5000 x 100 = 4%
74
Why might the market price of a bond increase?
Due to the strong investor demand
75
Due to strong investor demand e,g, £5500 the bond is now sold on secondary market for this what is the bond yield?
£200/5500 X 100 = 3.64%
76
What is the relationship between Bond prices and market interest rates?
A rise in the market price of bonds lelads to a fall in the yield on a fixed interest bond, there is an inverse relationship.
77
What is the central bank and give 2 examples?
The central bank manages the currency, money supply and interest rates in an economy
Federal reserve - US
Bank of England - Uk
78
What are 4 roles of the central bank?
1) Implement monetary policy
2) Target/ control inflation
3) Lender of last resort
4) Banker to the government
79
What does Lender of last resort mean?
help support banks by acting as a lender of last resort if they have a temporary shortage of liquidity
80
What does Banker to the government mean?
act a banker to the government in that they manage national debt e.g by issuing bonds.
81
What does reserve ratio mean?
The % of depositors balances that banks must retain as cash.
82
What is the formula to see how much extra money can be created from an inital deposit with an example ,for banks to create credit?
Money multplier = 1 / reserve ratio
E.g. if someone deposits 100 in bank the bank might reserve £10 and lend 90 to someone else, which will come back so the money multiplier is 1/01 = £10 times that by 100 and you have increased the money supply to £1000 (so you could essentially lend out this money.
83
What it the money multiiplier apart of?
Fractional reserves which is a way in which the modern banking system creates money by expanding the money supply beyond the money created by the central bank.
84
Why is fractional reserves sustainable?
if people have confidence in banks it means that they will not demand all their money meaning that it is sustainable.
85
Fractional reserve banking is essentially what?
an explansionary monetary policy an evaluation is that of it is that it depends on the confidence that people have in banks. if confidence is low people will demand all of their money.
86
What is monetary policy?
The central bank taking action to influence interest rates, the supply of money and credit and the exchange rate to help achieve the macroeconomic objectives.
87
What are the current objectives of the monetary policy?
- keep inflation 2% (plus or minus 1 %)
- financial stability
- maintaining growth
88
What is the role of the MPC?
Decide whether the BoE needs to change interest rates in order to achieve their monetary objectives.
89
What factors are considered by the MPC?
GDP growth and spare capacity
- bank lending
- house prices
- consumer confidence
90
What are the effects of central banks increasing exchange rates?
- fall in exports, increase in imports
- fall in demand pull inflationary pressures
- fall in cost push inflation
91
What are the effects of the central bank decreasing exchange rates?
- rise in exports, fall in imports
- rise in demand pull inflationary pressures
- rise in cost push inflation
92
What does Bank rate mean?
it is the lowest rate at which the bank of England will lend to fiananical instiutions ( banks), although this isn't the rate that you'd pay if you applied to a bank for a mortgage.
93
What is the monetary policy transmission mechanism?
- bank rate rises
- exchange rate rises
- people import more, less is exported
- market rates rise
- asset price fall ( less people demand houses, pushing price down)
- people feel less confident, fall in domestic demand
- domestic deflationary pressure
- possible deflation
94
What are 3 main effects of an increase in interest rates?
Cost of borrowing increases
Less investment by firms
Less consumer spending
95
What are 3 effects of a decrease in interest rates?
Cost of borrowing falls
more investment by firms
More consumer spending
96
What are the monetary policy tools?
1) Interest rates
2) Supply of credit
3) Exchange rate
4) QE
5) Forward guidance
6) Reserve ratio
7) Qualitative control
97
What is another phrase for Interest rates and Exchange rates?
- domestic price of money
- external price of money
98
How does an increase in the interest rate affect the exchange rate?
Increase in Uk interest rate --- Better return on UK savings account --- Hot money flows into the Uk to take advantage of higher interest rates --- Increased demand for sterling ---- Appeciarion in the value of sterling.
BOP worsens as SPICED
99
How does a decrease in interest rate affect exchange rate?
Decrease in UK interest rate --- lower return on UK savings ---- Hot money flows out of the economy ---- Increased supply of the pound --- depreciation in the value of sterling
BOP improves because of WPECID
100
Does a lower interest rates only have an effect on the monetary side?
There is also a supply side effect because lower interest rates can increase investment ( more likely)to borrow money, to purchase capital goods, increasing LRAS)
101
What is forward Guidance?
Forward guidance is verbal assurance from a country's central bank to the public about its intended monetary policy.
102
How could forward guidance be used?
BofE may say that they intend to keep interest rates low, encouraging commercial banks to offer low interest rate loans as they know that they will be able to get cheap loans from the central bank.
103
Why is Forward guidance particularly useful?
If interest rates are low, it could be lowered further
104
What are qualitative controls?
Limits on the types of loans that banks can offer e.g. not lend to those who don't have jobs because they are unsecure ( you don't know if you get back the money)
105
give an example of how central banks target inglation using interest rates?
When inflation is too high (5%) central banks can increase interest rates, shifting AD to the left
106
How can the reserve ratio increase the money supply?
When central banks want to increase the money supply in the economy. it might lower its reserve ratio, meaning that commerical banks have higher funds to lend as loans, increasing money supply in the economy ( money multplier)
107
What is Quanitiative easing?
TBA
108
What is the liquidity trap?
Is the idea that people are pessimistic about the future state of the economy, they may prefer to hold money they already have ( rather than spend it) and want borrow more. So loweing interest rates won't affect the consumer, making MP ineffective.
109
What are 5 factors that affect the effectiveness of monetary policy?
Time lags
Excess capacity in industry
Interest rate elasticity of goods and services
Other policies in use
Judging sucess
110
How does a time lag effect the success of a monetary policy?
The monetary policy transmission mechanism can take six months to two months, e.g. house buying can take a long time, people to purchase a suitable home for themselves, which takes time.
111
How does Excess capacity industry affect the monetary policy?
During a recession cutting interest rates to increase AD will be successful because the economy has room to expand. But during a boom it is not a good idea as it will lead to inflation.
112
Also for excess capacity, if there is lots of spare capacity in the economy is there incentive to expand?
There is less of an incentive to expand , so lower interest rates won't be useful as we might think. Although, lower interest rates may allow businesses to invest in creating extra capacity to makr the first issue less of a problem.
113
How does interest rate elasticity of goods and services effect sucess of monetary policy?
more likely to be a significant change in demand for more interest rate sensitive goods such as cars and houses
114
How is other policies in use a factor affecting the effectiveness of monetary policy?
Government policies may conflict with the BOFE policies e.g. tax increases/decreases.
115
How is Judging Success a factor that affects the success of a monetary policy?
Is inflation at the cost of employment considered success.
116
What is evaluation of monetarty policy making loweing interest rates making exchange rates lower, meaning WPECID, leading to increase in AD?
Depends on the PeD of our exports. For those exports which are PED elastic, we will see a bigger increase in demand than goods which are inealstic
Eval 2 The degree of elasticity depennds on the avaliablitiy of subsitutes and the quality of goods amongst other goods.
117
What does the Long run Philips curve state?
That in the long run output will always return to the full employment level
118
What is the AD/AS curve in the Long run Philips curve?
119
Explain the classical model of Long run philips curve?
assume that an economy is operating at its NRU
- at this point, inflation is 0% and workers will expect it stay at 0% so won't demand pay rises
- if AD increases, the economy will move along the SRPC with unemployment falling and inflation rising to 3%
- workers will now expect inflation to stay at 3% so will demand higher wages
- higher wage demands will make firms less willing to employ, so employment will fall back to the NRU but inflation will remain at 3%
120
What does the long run philips curve tell us?
It tells us the Natutal rate of unemployment but also the Nairu ( Non-acccelarting Inflation rate of unemployment)
This is the lowest rate of unemployment that exists in the UK in the long run without leading to changes in the rate of inflation.
e.g. If nairu is 5% then unemployment below this will lead to an increase in inflation, but unemployment above this rarw will not.
121
How do you show that in the long run, supply side improvements will be needed to reduce the level of unemployment?
- increase AD beyond LRAS
- shift SRAS back as resources becomes so scarce and expensive
- new equilibrium at the same level of unemployment
- therefore, demand side factors don't help in the long run, you need supply side improvements
122
So the philips curve show that in the LR demand side policies do not help to increase growth in the long run so what can?
Supply side policies thats the only way to reduce the NRU to see an increase in growth and reduction of unemployment, with lower rates of inflation
123
How would a supply side policy reduce NRU on a diagram?
124
What supply side policies can be used to reduce NRU?
Policies to reduce frictional unemployment such as income tax cuts
Policies to reduce structural unemployment ( investing in employment schemes to improve skills and also giving workers subsidies to move different areas
125
**What are the different sectors?**
Primary - extraction of raw materials
Secondary - producing finished goods
Tertiary - services and intangible goods
(Quaternary - information)
126
What is the trade off and evaluation economic growth and inflation?
- however in the long run, the level of the conflict depends on where they are on there LRAS - show different AD changes on LRAS
127
What is the trade off betwen economic growth and the environment? and eval
- using up scarce resources and externalities
Eva;
- depends what sector
- government could implement policies such as tax incentives for firms to GO GREEN! so there is no conflict
128
What is the evaluation for the trade off between budget deficit and unemployment?
However less goverment spending could increase incentive to work.
Eval squared depends on how much is reduced
129
What are Monetary and Supply side policies best use?
Monetary policy to tackle demand pull inflation
The supply side policies to tackle fricitional and structural unemployments which are often used to tackle cost push inflation.
