MACRO Flashcards
Characteristics of Money
- durable
- portable
- divisible
- Hard to counterfeit
- Must be accepted by the population
- valuable
- scarce
Functions of Money
- Medium of exchange-allows goods and services to be traded without the need for a barter system.
- Store of value- any assets who’s ‘value’ can be used now or in the future.
- Measure of value- value of something that is expressed in an undesirable way.
- Standard of deferred payment- expressing the value of debt.
money supply
-The Bank of England makes sure it creates enough banknotes to meet the demand for them.
M0-notes and coins plus central bank reserves
M2M- notes and coins plus all sights deposits held by the non-bank private factor.
M2- notes and coins plus all retail deposits held by non bank private sector.
M4- notes and coins deposits, certificates of deposits, securities with a maturity of less than 5 years held by non bank private sectors.
Narrow Money
Is a measure of the value of coins and notes in circulation and other money equivalents that are easily converted into cash, such as short term deposits in the banking system.
Broad Money
Measure of the total amount of money held by households and companies in the economy-made up mainly of commercial banks.
Motives for money
- Transaction motive–to pay for goods and services
- Precautionary motive–investment that rarely loses value
- Speculative motive-provide a return to their holder.
Gresham’s Law
Bad money drives out good money.
coins composed of the cheaper metal will be used for payment, while those made of more expensive metal will be hoarded or exported and tend to disappear from circulation
Factors affecting Supply of money
- open market operations- (same as quantitative Easing) the Central Bank buys government Bonds effectively creating money.
- The reserve requirement imposed on banks- % of deposits made by customers at the bank that the bank must keep a hold of rather than lend out.
- the policy interest rate set by the bank of England- rate of interest will influence how many households and businesses are willing and able to borrow
Factors affecting demand of money
- rate of interest on loans.
- number/value of monetary transactions that we expect to carry out
- the extent to which we want to hold other financial assets (e.g. bonds, property, saving) known as speculative motive for holding money.
- change in GDP
- extent to which it is possible to use debit cards/credit cards
- extent to which we might have to pay out large unexpected payments
- rate of anticipated inflation
Money markets
Money for short term loan finance for businesses and households
- money borrowed and lent for 12 months
- includes internal bank lending
- includes short term govt borrowing to help fund govt budget deficit.
Capital markets
markets for medium-longer term loan finance
- markets where securities such as shares and bonds are issued to raise medium to log term financing
- raising finance to fund govt budget deficit through issues of bonds.
govt bonds
a promise to pay periodic interest payments and to repay the face value on the maturity date.
where hot money goes
- bank accounts
- shares
- property
- currency
- bonds/debentures
- antiques
Foreign Exchange markets
market where currencies are traded-no single currency market made of thousands of trading floors
- spot exchange rate is the price of a currency to be delivered now
- forward exchange rate is a fixed price given for buying a currency today to be delivered in the future.
Role of financial markets
- to facilitate saving by businesses and households.
- to lend to businesses and households
- to facilitate exchange of goods and service
- provide forward markets to currencies and commodities.
- to provide a market for equities (shares)
sources of business finance
long term
- share capital
- retained profits
- venture capital
- mortgages
- long term bank loans
medium term
- bank loans
- leasing
- hire purchase
- govt grants
short term
- bank overdraft
- trade creditors
- short term bank loans
- factoring
Debt finance
borrowing money from an outside source with promise of paying back borrowed amount, plus interest, at a later date.
Bank Loans
- loans provided over a fixed period
- timing and amount of loans repayments are set by the lender.
- unsecured loans pay higher interest rates because of risks
Benefits -greater certainty of funding, provided terms of loan complied with it -lower interest rate than bank overdraft -appropriate method of financing fixed assets. Risks -requires security -interest paid on full amount -harder to arrange -startups and small businesses excluded.
bank overdraft
short term facility-banks let business “owe it money” when bank balance goes below 0.
Helps businesses handle seasonal fluctuations in cash flow or when business run s short term cash flow problems.
Equity
equity finance
sales of shares don’t have to be paid back, only pay dividends
raising capita; by selling shares of the business to investors
Advantages/ disadvantages of equity finance
advant
- equity is risk capital and doesn’t offer a fixed return-business has some control over when to pay a dividend to investor.
- gives businesses more flexibility
disadvant
- dilution of ownership for the original founders
- equity require higher return than debt as it is risk capital.
- growing expectations overtime that dividends will be paid.
Public sector debt
owed by central and local govt and by public corporations
Private sector debt
owed by private businesses and households.
- companies borrowed finance for investment
- households have loans such as credit card debts and mortgages on properties.
Benefits/disadvantages of bank overdraft
advant.
- easy to arrange
- flexible
- interest, only pay amount borrowed under facility
disadvant.
- withdrawn at short notice
- interest charge varies with change in interest rate
- higher interest rate than bank loans.
Advantanges/disadvantages of debt finances
advantages
1. less capital required to be invested by the shareholders
2. debt can be a relatively cheap source of finance compared with dividends
3. easy to pay interest if profits and cash flows are strong
Disadvantages
1. Business may be vulnerable to unexpected changes in interest rates
2. Businesses have less control of events if they are highly geared
Primary markets
secondary markets
govt issue bonds
reselling he bonds for higher prices
how commercial banks make profit
take deposits, lend them put at a higher rates then pay back a small amount and keep the rest to make profits.
they also charge fees.
Limits to profits made by commercial banks
- market forces- the scale pf profitable lending opportunities
- regulatory policy
- behaviour of consumers and businesses
- monetary policy
Liquidity risk
- banks attract short term deposits
- lend for longer periods of time
- so banks can’t repay all deposits if savers withdraw funds
- to reduce liquidity risk banks will try to attract long term deposits and hold some liquid assets as capital reserves.
Credit risk
- risk to bank of lending to borrowers who can’t repay loans
- can be controlled by safeguards/ worthiness of the borrowers
- controlled through regulations-e.g. size of reserves banks should hold back in case of bad debts.
Financial Policy committee of the bank of England
- FPC’s role is to identify, monitor and take action to remove or reduce risk that threaten resilience of UK financial system.
- publish financial stability report to identify key threats to stability
- have the power to instruct banks to change capital buffers
- increasing capital buffers help absorb unexpected losses on assets.
Uk Potential Regulation Authority (PRA)
Part of BoE, responsible for prudential regulations and supervision of around 1,700 banks, building societies, credit unions, major investment firms.
Finacial Market Failure (moral hazards)
exist in markets where individuals or organisations take more risks than they should because they know they are covered by insurance or govt will protect them from damage incurred by those risks.
Financial Market Failure (monopoly)
the abuse of a power resulting from a concentrated market.
e.g. when a small number of firms in the market choose to work together to increase their joint profits and exploit consumers.
Financial Market Failure (speculation)
risky action in which a person or organisation/ organisation tries to predict what will happen to the price of an asset and buys/ sells accordingly to make profit. — a speculator takes advantage of fluctuations in the market.
Financial market failure (externalities)
negative externality exists when a market transaction has a negative consequence on a 3rd party.
positive externality exists when a market transaction has a positive consequence on a 3rd party.
network externalities are when there are knock-on effects of organisations working together—-this is a synergy if the effects are positive and a discord if the effects are negative.
Moral Hazard –banking instability
when an agent is given implicit support guarantee in the event of making a loss.
in commercial banking- the govt absorb the losses.–banks take more risks since they believe they receive private benefits from the risk taking.
guaranteeing the deposits of savers may mean that banks can attract deposits by offering lower rates of interest.
Systematic risk
the possibility that an event at the micro level of an individual bank or an insurance company could then trigger severe instability or collapse an entire industry or economy.—if the financial world is interconnected.
Financial Conduct Authority (FCA)
funded by firms it regulates
3 aims:
1. secure an appropriate degree of protection for consumers
2. protect and enhance the integrity of the UK Financial system.
3. promote effective competition in the interest of consumers
Asymmetric info
type of market failure that exists when one individual or party has much more info than another individual or party and uses it to exploit other parties.
Speculative bubble
exists when the price of something is driven well above what it should be, usually due to the behaviour of consumers.
principle agent problems
when one person is able to make decisions on behalf f another person but the principle is unable to adequately supervise the agent. Agent can act to their own interest rather than interest of principle.
Incomplete markets
exists when the available level of supply is not enough to meet the needs and wants of consumers
Financial instability and real economy
Instability and confidence-
- negative impact on business investment
- increased saving and lower demand
- high levels of debt and falling asset prices hit consumer wealth and spending.
Instability and loss of trust-
- people have less trust in banks and other institutions
- high interest rates on loans to businesses.
- credit harder to get for small and medium sized enterprises and start ups.
instability and inequality-
-poorer communities and families are more vulnerable during periods of financial recesion.
GDP-gross domestic product
the total value of output of goods and services produced within an economy in a given time period.- an increase in the productive capacity of the economy from one year to the next
Economic growth
usually calculated in real terms (adjusted for inflation) in order to net out the effect of inflation on the prices of goods and service produced.
GNP-gross national product
measures the final value of output or expenditure by UK owned factors of production whether they are located in the UK or overseas.
GNP=GDP+Net property incomes from abroad (net income flows).
-once calculated it is converted to US dollars and divided by the countries population to give GNP per head.
net income flows
net balance of interest, profits and dividends coming into the UK from UK assets owned overseas matched against the flow of profits and other income from foreign owned assets located in the UK.
problems with GDP
- cost of living is different in different countries
- distribution of wealth is different in different countries
- patterns of expenditure are different.
- quality of life
- non market activities-hidden markets (such as house wives)
- environmental factors
- happiness and well being
- the shadow economy
other issues-
-statistical inaccuracies
-income is not distributed on a per capita basis
Standard of living
refers to the amount of goods and services consumed by households in one year
standard of living= real national income/population
-high standard of living means households consume large number of good and services.
PPP-purchasing power parity
measures how many units of one countries currency are needed to buy exactly the same basket of goods as can be bought with a given amount of another countries currency.
-used
Human Development Index
focuses on basic education, minimal income and life expectancy
- knowledge (takes into account mean years and expected yrs of school)
- Long and healthy life (calculated using minimum value of life expectancy of 5 and max of 85)
- Standard of living (GNI adjusted for PPP standard).
-fails to take into account of qualitative factors, such as cultural identity and political freedoms (human security, gender opportunities and respect of human rights).
GCI-Good Country Index
- science + technology
- cultural
- internal peace and security
- world order
- planet and climate
- prosperity and equality
- health and wellbeing
Benefits of economic growth
- Boosts living standards through higher real GDP per head (reduces absolute poverty)
- increased output generates new jobs and reduces unemployment-as labour has derived demand.
- increased tax revenue can be used to fund extra spending on public and merit goods and services.
- improved business confidence -attractive o foreign investment inflows.
- higher consumption leads to induced increases in investment spending-accelerator mechanism
- growth acts as spur to introduce new technology which spurs innovation.
risks of economic growth
- environmental impacts-fast growth may create negative externalities
- depletion of non-renewable resources causing ‘resource poverty’
- increased pollution/waste/congestion
- energy crisis
- concerns about sustainability of growth for future generations.
increased inequalities in income and wealth
- widening gap between rich and poor
- higher levels of relative poverty
renewable resources being depleted because of over consumption.
- destruction of rain forests
- permanent loss of natural habitats through construction of roads, retail malls and industrial estates.
growth and environmental threats
- depletion of natural resources and impact of global warming
- over-population putting increased pressure on scarce land
- pollution of the environment both by produces and consumers.
could economic growth improve the environment?
- per capita income rises-new wealth can be used to buy cleaner fuels like natural gas.
- richer countries have resources to research and develop cleaner and less resource-intensive production tech.
- higher real income associated with lower fertility rates reduces natural rate of pollution growth.
Supply-side policies
-privatisation
- selling government owned assets to the private sector could increase competition. Firms will want to reduce their costs through innovation so agg demand will increase.
- disadv; this process could lead to a monopoly situation and consumers could lose out through higher prices
- disadv; once a business is sold it is sold.
Deregulation
-form of privatisation
would enable greater competition would lead to profit maximisers increasing supply as prices would lower.
Encourage enterprise and business investment
- cut bureaucracy (red tape) to make life easier for firms and help them cut costs. May gove money to new businesses .
- more small businesses
- by giving grants and reducing coorporation tax the govt can encourage competition and efficiency. As productivity improves it will produce more with a given amount of resources and increase LRAS.
Trade unions
trade unions try to push wages above the market equilibrium- govt try to reduce their power which makes labour markets more flexible and efficient with more workers not striking there is increased productive potential.
Spending on education and training
- if the work force is better trained and has more skills then it will be more productive and our AS will increase. So govt can invest in training schemes such as apprenticeships.
- depend on the level of youth unemployment.
- depend on the quality if training.
- disadv; opportunity cost.
- adv; creates jobs in the training market.
Lower income tax
- cutting income tax will give workers a higher disposable income and should make working more attractive e.g. doing more overtime.
- disadv; could reduce govt revenue.
- BUT may increase govt revenue as more people may end up working as a result.
- Success depends on the size of the tax cut.
- success depends on the duration of the tax cut.
cut welfare benefits
- cutting benefits can act as an incentive to take up work. It reduces the opportunity cost of working. So the active labour force increases.
- Adv; reduces govt spending, money can be spent elsewhere.
- disadv; hits the poor the most
- success depends on the size of the cut.
Unemployment
those people able, available and willing to work who can’t find a job despite an active search to work.
- scares human resources are not being used to produce the goods and services that help to meet people’s changing needs and wants.
- high levels of unemployment have damaging scarring consequences for an economy causing economic costs and social costs.
claimant count
number of people officially claiming unemployment benefits- must be actively seeking work.
Labour force survey
labour force
- all those actively seeking and available for work whether or not they are claiming benefits
- the number of people of working age who are able, available and willing to take work.
seasonal adjustment
- agg demand for labour varies at different times of the year due to seasonal changes in the number of jobs on offer.
- purpose of seasonal adjustment is to remove the variations associated with the time of the year.
Types of unemployment
- Seasonal- regular seasonal changes in employment/ labour demand.
- Structural- when there is a mis-match between the skills of those unemployed an the skills that new jobs require- linked to labour immobility.
- Frictional- unemployment related to the process of changing jobs, which may involve a period of time out of work.
- cyclical- category of unemployment whose number varies according to business or economic cycle.
- Real wage- when a rise in real wages above the market clearing level causes a contraction in labour demand and an extension in labour supply.
- Hidden- unemployment which is known to exist but is not included in official govt figures.
economic and social effects of high unemployment.
economic costs-
- lost output, the economy is inside the ppf (lost efficiency)
- fall in real incomes and lower living standards for those affected
- drop in tax revenues and higher welfare- budget deficit.
- possible decline in labour supply as unemployed move overseas.
social costs
- increase in relative poverty and benefit dependency
- extra demand on NHS- due to stress
Beneficial effects
- reduced risk of inflation= lower wage claims and price discounts.
- unemployed available for growing businesses
- rise in self-employment start ups as alternative to being unemployed.
Labour scarring effects from high unemployment.
loss of work experience
- reduced employability from depreciation of skill.
- gaps in CVs may influence potential employers
- decline in quality of human capital.
loss of current and future income
- vulnerability to consumer debt at high interest rates.
- decline in physical health and increase in stress.
Changing patterns of jobs in the economy
- new jobs in recovery stage are diff from lost jobs.
- structural unemployment–occupational immobility makes it hard for people to get jobs.
youth unemployment
young people out of work risk fall in their expected lifetime earnings from work.
- skills gap= employers not willing to employ people who lack ability to read or write
- reluctant employers= prefer older more experienced workers.
- falling retirement rates= caused by decline in pension incomes leads to fewer jobs for youths
- weak macro fundamentals= e.g. low real GDP growth and business confidence.
policies to reduce unemployment–labour demand
macro stimulus policies (+multiplier effect)
- low interest rates and policies to increase business lending
- depreciation in exchange rates
- infrastructure investments projects.
cutting the costs of employing workers
- reduction in the national insurance contribution tax
- financial support for apprenticeship programmes
- extra funding for regional policy-business grants.
competitiveness policies
- reduction in corporation tax to increase investment
- tax incentives for research/ innovation spending.
- Enterprise policies to lift rate of new business start-ups.
policies to reduce unemployment–labour supply
reducing occupational immobility
- better funding for and more effective training
- teaching new skills
- expansion of apprenticeships/ internship
improving geographical immobility
- rise in housing building will help to keep property prices lower and encourage affordable rents.
- active regional policy to create new jobs/businesses.
stimulate stringer work incentives
- higher minimum wage or living wage.
- reductions in income tax/ national insurance.
- welfare reforms to reduce the risk of the poverty trap
key barriers to lowering unemployment
- high levels of long term structural unemployment in the UK.
- pockets of exceptionally high unemployment and low economic activity rates , high youth unemployment.
- hard to overcome the disincentive effects of :
- a complex welfare benefit and tax system
- unaffordable housing sector
- low-paid jobs that keep families in relative poverty
- high costs and uneven availability of quality child care
- high rates if public sector dependency
- many people are under-employed and stuck in part time jobs.
- skills shortages, creaking infrastructure and variations in educational performance and opportunities
- weak demand in domestic and export markets.
benefit of fall in unemployment
- increased employment-boosts real GDP, helps lift living standards and demand.
- more people in work- creates extra tax revenue for the govt either to lower deficit/ increase spending.
- social costs of high unemployment are severe.
disadvantage of falling unemployment
- extra spending from expanding labour market might worsen the current account.
- risks of an acceleration in demand pull and cost push inflationary pressures if unemployment falls rapidly.
- fewer spare labour will mean a rise in unfilled vacancies labour shortages might put off some inward investment.
Natural rate of unemployment
involuntary unemployment–when there are too few goods in the economy at existing wage rates, and those who are actively searching for a job can’t find one.
voluntary unemployment– those who chose to to reject employment as they search for position with, for example, better pay or benefits.
Factors affecting size of natural unemployment
- level of welfare benefits
If welfare benefits are high compared to wages then the opportunity cost of work is also high. With high benefits there is less incentive to work-people may remain voluntarily unemployed.
Level of income tax in the economy
Low income tax acts as an incentive for people to find work as the opportunity cost of staying unemployed will be higher, so natural rate of unemployment will fall.
Trade unions power and military
If trade union are powerful they could push up wage rates encouraging more people into work. However, also above firms may find it expensive to take on more work.
Level of wage controls
If wages are set at a minimal level then more people will be encouraged to find work. NRU will be low–at this rate employers may offer less jobs and increase part time.
Degree of labour immobility
If labour is mobile then NRU will be low– refers to occupational, geographical and industrial immobility.
Rate of change in the economy and ability of workers to adapt to changes
If there is a fast rate of change in the economy and if workers are able to change and be skilled then NRU will be low.
Social attitudes and institutions
Stigmas that prevent people taking jobs e.g. working at McDonald’s. If the occupation is looked down on then many may choose to not take up the job.
Inflation
general rise in the average price from one year to the next—a fall in the value of the pound.
Deflation
A reduction in the average price level from one year to the next.
Causes of Demand pull inflation
most likely to occur when there is little spare capacity in the economy
- Increase in money supply
- depreciation in the exchange rate
- reduction in tax both direct and indirect
- increase in house prices
- booms in the economies of trading partners.
Wealth effect
As the value of your house increases, your wealth increases and so security increases–able to borrow more and buy more.
Cost push inflation
Caused by the economy–when there is a wide increase in production costs
- external costs e.g. a rise in the price of imported materials–imported inflation
- rising labour costs
- higher indirect taxes–one off
- wage prices spiral
- depreciation of exchange rates–artificial reasons
Quantity Theory of Money
Theory that states that inflation is caused by a prior increase in money supply (monetary).
Fisher’s equation of exchange
money supply (stock of money) x Velocity of circulation of money = Price level x standard of transactions
or MV=PT
Consequences of inflation
uncertainty
inflation affects prices and costs to businesses making it difficult to plan for the future.
extent depends on
1. how much our raw materials are domestic/foreign
2. may matter less for products with an inelastic demand, as increased costs can be passed onto price
3. how much of our raw materials are brought in advance on a contracted basis.
Saving are eroded
Money put in banks or loaned out loses its value
extend depends on
1. interest rates relative to inflation
2. made worse if there is a disincentive to save and AD further increases
3. less money in banks available for investment
People on fixed incomes lose purchasing power
Prices rise while incomes don’t.
extent depends on
1. amount of people on fixed incomes
2. may act as an incentive to take up work to reduce unemployment.
Possibility of a wage-price spiral
Higher prices may lead to workers demanding higher wages as they don’t want their real standards of living falling.
extent depends on
1. trade union power
2. skills of workforce
Loss of international competitiveness
the economy will become internationally uncompetitive if other countries don’t experience inflation at a lower rate. Exports will become relatively expensive and import relatively cheap.; balance of trade will deteriorate
extent depends on
1. economies reliance on exports-size of export market
2. inflation in other countries.
3. price elasticity of exports (few substitutes, necessities ect).
Breakdown of the price mechanism
- prices act as signals to allocate resources.
- price goes up, supply expands and demand contracts.
- The higher prices act as signal to producers to increase production in areas which are more profitable.
- though if there is inflation, higher prices don’t make profit.
