financial sector essays/ revision

Question 1

Evaluate the relevance of the quantity theory of money

Answer 1

Intro- Fischer equation
Point 1-relevant because it explains how inflation occurs (V and T are assumed constant by monetarists)

point 2-helps government match their approach to inflation with the cause ie focusing on supply of money via monetary policy and fiscal policy
-also becomes self-fulfilling because

-point 3- not relevant because other factors can influence inflation ie confidence, also just focusing on monetary supply can adversely affect other objectives

Question 2

evaluate the importance of the financial sector to a developed country

Answer 2

intro- financial sector and developed country definitions

• why its important- role of banks is confidence, savings, investment etc, so it can be the driving force in encouraging economic growth and achieving objectives
• why its important- biggest source of revenue for the UK, attracts inwards FDI and foreign currency reserves because of how strong and successful it is
• why its importance might be overstated- speculation in the financial sector has led to rising asset prices and gambling of consumer savings for short term returns and profits, normal banks were becoming investment banks prior to 08-09 crash, creating wealth via rising asset prices rather than innovation and supply side policies, all about the short term rather than sustainability, also attracts skills in high demand like maths and science, diverting them away from more productive jobs

depends on market failure- the motivations of the finance sector are self fulfilling and ignore the wider economy, more about short term profits and returns. Doesn’t encourage sustainable long term investment

Question 3

Evaluate the importance of financial sectors in developing and emerging countries

Answer 3

definition of developing and emerging economies

• important because they help to achieve macro economic objectives, due to different levels of development to developed countries the main priority of financial sectors in developing countries is ensuring a framework to make them stronger
• important because as they become more developed, they are increasingly attracting inwards FDI which strengthens the rest of the country
• importance of Microfinance- under-developed financial sectors introduce increased risk and many are cut off from access due to geographical considerations, Microfinance from philanthropists and more socially aware banks provides finance and advice and bank accounts for those who can’t access traditional banking,
• depends on motivation of banks and how developed the finance system is, wont succeed if they are only concerned with profits, and under-developed banks add problems of corruption

Question 4

Effectiveness of different banking policy methods in achieving its primary and secondary objectives

Answer 4

Primary and secondary objective definitions

-why they may be effective-BoE target of 2%, deflationary monetary policy ie higher interest rates can lower demand pull inflation, use of QE in times of lower than needed inflation, SRAS and SRAD diagrams to show moving inflation in the short term

• why it may not be effective- pursuing an objective of 2% may happen naturally so may waste time and resourced trying to do it
• liquidity traps which render monetary policy useless ie after 09 crash
• QE may not be used by banks to increase lending, may just fix their finance sheets instead

Question 5

Evaluate the importance of regulation of the finance system

Answer 5

Benefits of regulation

• protects consumers from banks running in a more risky manner, gambling investments and savings for short term profits
• increased rules mean banks are less likely too pursue profits at the extent of their customers, profits now limited
• financial sector problems that exist under new regulation less likely to introduce contagion as these problems should be less severe if banks adhere to these rules
• drawbacks
• disincentive effects- institutions may not want to adhere to such rules because it reduces their profits, therefore they relocate to areas with comparatively more freedom such as Asia, reducing the GDP of the country
• may still be under regulation- banks adhering to the letter of the law but not the spirit of the law, finding loop holes, continuing in a risky manner if the rewards are higher than the possible fines

Depends on extent of government failure

Question 6

Advantages and disadvantages of world bank and IMF in helping growth and development

Answer 6

Advantages

• world bank provides long term loans and advice to help fund projects in developing countries
• IMF more concerned wit short term loans to overcome balance of payment problems and encourage growth
• both have their respective importances in differing developed countries

Disadvantages

• they are sometimes criticised for putting American led values on countries with different values and culture, leading to unsavoury political problems in the country
• they may not charge fair conditions on the loan which make them unsustainable in the long term
• they may not get the balance right in terms of sustainability or environmental considerations
• they focus too heavily on the private sector because they are often profit motivated, which isn’t applicable in all countries

depends on- their efforts, the country, government failure in mitigating the external banks mistakes, sustainability

Question 7

Evaluate central bank independence

Answer 7

Independent central bank ie BoE defined

Advantages
-may have more credibility and they pursue low inflation rates to achieve their primary objectives. People have more confidence in an individual bank, which helps to reduce inflationary expectations

Disadvantages

• ECB have been criticised for sticking too rigidly too their inflation targets, therefore they ignore more pressing issues and employment or balance of payment problems can suffer as a result
• also building up bigger debts by keeping inflation low with higher interest rates

depends on-viewpoints weak growth and liquidity traps have taken over, the public have no control over the running of the central bank, but their decision making influences the livelihood of the public

Question 8

Why do interest rates vary across the money marker?T

Answer 8

Lenders try to balance risk against security, therefore if its low risk or high security they will encourage low interest rates (mortgage) and vice versa if it is very risky and unsecured they give higher interest rates

Question 9

3 services of the finance sector

Answer 9

• credit provision
• liquidity provision
• risk management

Question 10

3 problems with the financial market?

Answer 10

Speculation- the stock market has shifted away from a place for businesses to source finance, and more of a place of gambling from banks and investors to gain short term rewards with no business knowledge

corruption- banks like HSBC and RBS were fined for rigging FOREX markets for their own advantages

Caution- due to the financial crisis, banks are much less inclined to lend to smaller businesses, more regulation in place, which can be beneficial but can curtail growth to some extent if business and consumer confidence stays low