Financial sector

Question 1

What are the six roles of the financial markets

Answer 1

1. To facilitate saving
2. Lend to businesses and individuals
3. Facilitate the exchange of goods and services
4. Provide forward markets in commodities and contracts
5. Provide market for equities

Question 2

What are the five sources of market failure in financial markets

Answer 2

1. Asymmetric information
   - > PPI -> sold it as an extra when it was already included
2. Moral Hazard
   - > Banks to big to fail, they take risks that they probably shouldn’t as they know the government will bail them out
3. Speculation and market hazard
   ->Housing market -> prices go up -> wealth effect -> Increase AD
   The bubble bursts as first time buyers can no longer afford to buy a house
4. 3rd party externalities
   - > Austerity -> public sector pay freeze -> wealth effect -> increase AD
   - > Tax rates increased
   - > recession -> people lost jobs
5. Market rigging
   - >Main banks colluding on the Libor rate

Question 3

What is the role of central banks

Answer 3

Lender of last resort -> bail out the banks

Implement monetary policy
-> control inflation 2% +- 1% -> QE and I rates

In charge of regulating banking system