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Investment Practice > Macro-economics > Flashcards

Macro-economics Flashcards

1
Q

What are the four stages of the economic cycle?

A

Recovery/Expansion: IR↓, investment ↑, employment ↑, confidence ↑
Peak/Boom: Excessive demand, inflation ↑, IR ↑
Contraction/Slump: Output ↓, consumption ↓, confidence ↓
Trough/recession: Demand ↓, unemployment ↑, profits ↓, confidence ↓

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2
Q

What are leading indicators for forecasting economic performance?

A

Advance warnings of movements in the cycle e.g. share prices, house building activity, money supply, credit growth, IR

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3
Q

What are coincident indicators for forecasting economic performance?

A

Changes that occur at the same time as the overall economy e.g. levels of personal income

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4
Q

What are lagging indicators for forecasting economic performance?

A

Changes that occur after the overall economy e.g. unemployment rate, labour costs, business spending, bank loans.

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5
Q

How is economic development measured and what is it based on?

A

Using the UN’s Human Development Index (HDI) which is based on demographic factors, economic factors and social factors.

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6
Q

What would a classical economist argue?

A

In the LR, the economy will always operate at full employment, as there is an equilibrium were S = D. Govt. intervention therefore not necessary.

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7
Q

What would a Keynesian economist argue?

A

AD is the key driver in an economy. Govt. intervention therefore needed.

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8
Q

What is the marginal efficiency of investment?

A

The relationship between the interest rate and demand for investment.
- When IR ↓, investment ↑ - but this is dependent on confidence and govt. expenditure.

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9
Q

How do you calculate a simple multiplier?

A

1 / (1 - MPC) (1 - MPC = MPS)

Adjusted for tax: 1 / (1 - [ MPC(1 - tax rate) ])

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10
Q

How do you calculate an open-economy multiplier?

A

1 / (1 - [ MPC(1 - tax rate) ] + MPM)

MPM: Marginal propensity to import

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11
Q

How do you work out the MPC?

A

1 - MPS

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12
Q

What is the main focus of monetarism?

A

Controlling inflation with interest rates.
Based on the Fisher equation: ΔM+ΔV = ΔP+ΔY
Δ Money Supply + Δ Velocity of Circulation = Δ Price of all goods + Δ Output (no. of transactions)

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13
Q

What is “fiscal easing”/”expansionary fiscal stance”?

A

A govt. spending more than it raises in taxes causing a budget deficit.

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14
Q

What is a “contractionary fiscal stance”?

A

Taxes ↑ without increasing spending.

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15
Q

What is a “natural fiscal stance”?

A

Taxes ↑ Govt. exp. ↑

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16
Q

What are the four main problems that are faced when determining an appropriate fiscal policy?

A

Time lags: Time between recognising an issue and seeing the effects of a fiscal response.
Political manipulation: Trying to achieve a boom in the lead up to an election.
Crowding out: Govt. exp. ↑, borrowing ↑ - IR ↑, consumption ↓, investment ↓.
Higher future tax rates: Govt. exp ↑, taxes ↑

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17
Q

What is a discretionary fiscal policy?

A

Implemented through budget process

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18
Q

What is an automatic fiscal policy?

A

Fiscal stance arising in response to economic changes e.g. introduction of progressive taxation, taxation ↑ - known as a ‘fiscal drag’.

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19
Q

What is the monetary base?

A

The total amount of money in circulation.

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20
Q

What is the “narrowest” definition of money (M0)?

A
  • Notes and coins in circulation outside of the BoE

- Banks’ operational deposits at the BoE.

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21
Q

What is the “broad” definition of money (M4)?

A
  • Private sector holdings of notes and coins
  • Banks’ retail deposits
  • Building Society’s retail shares and deposits and other interest bearing deposits.
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22
Q

What is the reserve ratio?

A

% of deposits the Banks are required to keep in order to cover their day-to-day operations.

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23
Q

What is fractional reserve banking?

A

A system in which only a fraction of bank deposits (reserve ratio) are backed by actual cash available for withdrawal. This done, in theory, to expand the economy by freeing up capital and gives rise to a potential money multiplier.

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24
Q

What are retail bank deposits?

A

Consumer deposits on standard bank terms.

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25
Q

What are wholesale deposits?

A

Large, one-off business deposits at negotiated rates.

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26
Q

Money supply equation:

A

Money supply = Monetary base x Multiplier

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27
Q

Potential money multiplier equation:

A

Potential Money Multiplier = 1 / cash reserve ratio

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28
Q

What is an “easing” monetary policy?

A

IR ↓

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29
Q

What is a “tightening” monetary policy?

A

IR ↑

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30
Q

What are the two main causes of inflation?

A

Cost-push inflation:

  • AS ↓
  • When firms respond to rising costs by increasing prices in order to protect profits.

Demand-pull inflation

  • AD ↑
  • When AD grows at an unsustainable rate causing increased pressure on scarce resources/excess demand.
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31
Q

Classical unemployment:

A

Due to the effects of supply and demand e.g. wages ↑, unemployment ↑

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32
Q

Structural unemployment:

A

Due to structural changes to economy e.g. industry closures.

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33
Q

Frictional unemployment:

A

Due to people temporarily changing jobs or being incapable of employment due to a disability.

34
Q

Keynesian/”Demand deficient” unemployment:

A

Unemployment on a national scale as a result of AD ↓

35
Q

What is the natural rate of unemployment?

A

The constant rate despite opportunity for full employment.

36
Q

What does the Phillips curve suggest?

A

That the inflation rate and unemployment rate have an inverse relationship.

37
Q

What is the leverage ratio?

A

Banks should have at least 3% of their assets at all times to avoid insolvency.

38
Q

What is the liquidity ratio?

A

Banks should hold a sufficient amount of high-quality liquid assets to cover its total anticipated net cashflows over the next 30 days.

39
Q

What are the three different types of exchange rate regimes?

A

Fixed: Govt. aim to maintain a target exch. rate.
Floating: No govt. intervention
Dirty Float: some intervention

40
Q

What is the delivery date for foreign currency SPOT transactions?

A

T+2

41
Q

How are SPOT rates quoted on the market?

A

Quotes bid/offer prices (SPOT rates) in the form of a spread, normally using the $ as the base. These quotes against the $ can be used to determine the quotes between any currencies.

42
Q

How are forward rates quoted?

A

As premiums (pm) or discounts (dis) to the spot rate. It is also possible for rates to be quoted at par where the spot and forward are the same.

43
Q

How are forward rates calculated?

A

You add the discounts and minus the premiums to the spot rate.
The forward rate is simply calculated on the basis that the money is invested at the current rate of interest in the two countries.

44
Q

What does the International Fisher Effect (IFE) state?

A

That the expected disparity between the exchange rate of the two currencies is approx. equal to the difference between their countries’ nominal interest rates.
e.g. Countries with higher nominal interest rates, experience higher rates of inflation, which will result in the currency depreciation against other currencies.

45
Q

Which two differentials does the IFE link together?

A

Interest rate differential and the inflation rate differential of PPP.
i.e. If SR interest rates generate the forward forex market and inflation differentials generate the expected change in forex rates –> these two must be approx. equal and the SR interest rates are determined by the inflation rate differential.

46
Q

What does Fisher state the nominal rate of return (r) is equal to?

A

1 + r = ( 1 + R ) ( 1 + i )

r = nominal rate of return
R = real rate of return
i = inflation
47
Q

What is assumed, when stating that the difference in nominal rates is generated by the differential in inflation?

A

That the real rate of return (R) does not vary between countries.

48
Q

What is calculation to work out the Forward Rate?

A

Future Rate = ( 1 + i(v) ) / ( 1 + i(f) ) x spot rate

49
Q

What does the Current Account deal with?

A

Goods, services, income and transfers.

50
Q

What does the Capital Account deal with?

A

Public sector flows of capital e.g. loans between countries

51
Q

What does the Financial Account deal with?

A

Flows of capital from non-government sector e.g. FDI, portfolio investment.

52
Q

What is the rule to remember with currency exchange?

A

All trades will result in paying for the currency or receiving the least, the FX dealer commission via the spread.

53
Q

Why may a depreciation in the exchange rate lead to a short-term deterioration in a country’s balance of payments?

A

Prices of imports and exports will change immediately, but demand for imports and exports will take time to change.

54
Q

What are the three methods of calculating inflation and how do they differ?

A

Consumer Price Index (CPI)
Retail Price Index (RPI) - includes mortgage payments and other housing costs
Producer Price Index (PPI)

55
Q

What is the “paradox of thrift”?

A

A collective increase in the proportion of savings will lead to a decrease in total savings.

i.e. if we all save more, demand ↓, national income ↓, total monetary amount saved ↓.

56
Q

What are the consequence of a higher than expected rate of inflation?

A

The nominal rate of interest will under-compensate for the higher inflation rate.
This would lead to a redistribution of wealth from lender to borrower and old to young.

57
Q

At what point is a country said to be in internal and external balance?

A
  • AD at full employment (internal balance)

- Current Account balance of payments balance (external balance)

58
Q

What impact would an increase in the money supply have on the economy?

A

IR↓, private sector investment to UK firms ↑

59
Q

Which central banks have the ability to set national interest rates that are separate to the government?

A

Bank of England (UK)
Federal Reserve (US)
European Central Bank (EU)
Bank of Japan (Jap)

60
Q

What shape is the long-run Phillips curve?

A

Vertical (where the natural rate of unemployment occurs)

61
Q

What is the US Federal Reserve responsible for?

A
  • Setting interest rates

- Banking supervison

62
Q

What does the fractional reserve banking system give rise to?

A

The potential money multiplier

63
Q

What are examples of leading indicators (5)?

A
  • Share prices
  • House building activity
  • Money supply
  • Credit growth
  • Interest rates
64
Q

What are examples of lagging indicators (4)?

A
  • Unemployment rate
  • Labour costs
  • Business Spending
  • Outstanding bank loans
65
Q

What is assumed about the MPC of the poor, as opposed to the wealthy?

A

It is higher for the poor, as they spend a larger percentage of their income, than the rich.

66
Q

How is the balanced budget multiplier best described?

A

Govt. Exp. = Revenues, National Income ↑

67
Q

What is the process of sterilisation?

A

A form of monetary action in which the central bank attempts to limit the effect of inflows and outflows of capital on the money supply.

68
Q

What does the consumption function plot against each other?

A

Expenditure against disposable income

69
Q

What is invisible trade?

A

An international transaction that does not include the exchange of tangible goods e.g. tourism

70
Q

What is it known as if the $ is the fixed currency?

A

An indirect quote

71
Q

What is it known as if the £ is the fixed currency?

A

A direct quote

72
Q

What does the forward rate of exchange reflect?

A

Interest rate differentials between the two currencies.

73
Q

What is the covered interest rate parity formula used to determine a forward rate of exchange?

A

Spot x ( 1 + r(v) ) = Forward x ( 1 + r(f) )

74
Q

How are spot and forward rates linked?

A

Interest rate parity

75
Q

What does the Taylor Rule suggest?

A

A 1% change in inflation (up or down) should be countered by a greater than 1% change in interest rates in the same direction.

76
Q

What does the “Debt Deflation” / “Credit Cycle Theory” suggest?

A

That the financial sector causes cyclical changes in the economy as a result of its attitude towards credit availability.

77
Q

What is an optimal currency area?

A

A geographical region in which overall economic efficiency will be maximised through the use of a single currency.

78
Q

What is the minimum level of common equity Tier 1 capital permitted by Basel III?

A

4.5%

79
Q

What is helicopter money?

A

The printing and distribution of money to the population, either directly or through infrastructure investments or tax cuts.

80
Q

What does the purchasing power parity theory of exchange rate determination state?

A

Differences in price levels/inflation are reflected in exchange rates. If domestic prices increase relative to another country, the exchange rate will depreciate.

Investment Practice (12 decks)

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