monetary policy Flashcards
what are the four functions of money
- a medium of exchange
-a measure of value
-a store of value
-method of deferred payment
what is the money supply
the stock of currency and liquid assets in the economy
what is narrow money
physical money and deposits and liquid assets in the bank
what is broad money
the entire money supply
what is the money market
the market in which liquid assets are traded, used to borrow and lend in the short term
capital market
where debt and capital instruments are bought and sold
what is the foreign exchange market
the market where currencies are traded mainly done by international banks
roles of financial markets in the wider economy
-to facilitate saving
-lend to businesses and individuals
-to provide markets with currencies and commodities
-provide market for equities
what is debt
money which has been borrowed from the bank, and the loan is later repaid with interest rates
what is equity
a stock or security which represents interest in owning e.g a firm,car or house
why is there an inverse relationship between market interest rates and bond prices
-when a bond is bought, money is lent to the borrower
-if the interest rate falls, the bond is worth more as it carries a higher IR than current market conditions and vice versa
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what is a coupon
bond interest payment
what is the maturity of a bond
the time the financial asset is outstanding
ways in which firms raise finances
issuing coroporate bonds
issuing shares
borrowing from a bank
why are corporate bonds isued
to fund large projects
-develop a product
-expand firm
-takeover another firm
what to do commercial banks do
-manage checkes, loans and deposits for individuals and firms
what do investment banks do
-facilitate the trade of stocks, bonds etc
4 main functions of commercial banks
-accept deposits
-provide loans
-provide overdraft
-investment of funds
what does the commercial banks balance sheet show
the value of a companys assets, liabilities and owners equity
3 main objectives of a commercial bank
-liquidity
-profitability
-security
main object - liquidity
how easy it is to turn the assets into cash, in order to be profitable banks must have cash
if liquidity is prioritised, profits will be low
cash is the most liquid
loans and long term bonds are the least liquid
if banks can borrow easily they will keep less liquid
main objective - profitbailty
to be able to pay their depositers interest, wages and general costs. lots of funds in cash means profitabilty is limited
liquidity and safety are more prioritised
main objective - security
have to try and maintain the safety of their assets
banks face uncertainties such as if loans will be repaid or not and in what time
a bank has to keep high portions of their liquid to itself and the central bank
banks only hold their safest assets so more credit cannot be created
how do banks make credit
- M1 money includes checkable deposits
-must keep enough money to meet liabilities, and the rest it can lend
-there a multiple banks in system, so only required to hold a fraction of deposits, and rest ends up in other banks
-this increases the money supply
banks create credit by doing what
loaning individuals and businesses moneypartly made up of deposits
what increases when commercial banks also involve in investment banking
systemic risk
3 main functions of a central bank
implement monetary policy
lender of last resort
bankers to the government
what does monetary policy in the central bank involve
influencing IR, the supply of money and exchange rates
the role of the MPC
alter interest rates to control supply of money
who is the base rate controlled by
the central bank
factors considered by the MPC when setting the bank rate
unemployment
savings rate
consumer spending
exchnage rate
high commodity prices
how does a change in the exchnage rate effect AD
depreciation- exports become cheaper, so export more and reduce trade deficit
issues with depreciation of exchange rate
inflationary pressure as increases price of imports
production costs for firms increase
causes cost push inflation
why do high IR attract foreign direct invetsment
the rate of return on investment is higher
which increases demand for the currency (appreciation of the currency)
effect of lower IR on exchange rate and trade
-hot money flows out of the economy, increasing supploy of the sterling
-fall in demand for pound
-causing currency to depreciate
-imports become more expensive and exports cheap (SPICED)
-M falls and X rises, so AD rises
what is the transmission mechanism
the process in which AD and the economy is effected by monetary policy decisions
monetary policy definition
using interest rates and monetary tools to influence levels of consumption and agreggate demand
2 main aims of monetary policy
- low inflation rate. the UK CPI target is 2%
-stable economic growth
what does increasing money supply increase
demand for commodities and investment
what does lowering money supply do
decreases demand
what is quantative easing
-creation of money to buy assets e.g govt bonds
-aims to increase money supply
example of large cut in interest rates
financial crisis 2008/9 the BofE cut IR from 5% to 0.5%
limitations of monetary policy
liquidity trap
effects on the exchange rate
TIME LAGS
2 things the government will use to regulate financial market
regulations and guidelines
what organisations regulate the UK financial system
prudential regulation authority PRA
financial conduct authority FCA
financial policy committee FPC
what is the role of the FCA
-ensure financial firms are being honest to customers and protect customer interests
-to promote competition
role of the PRA
promote the safety and stability of banks and ensure policyholders are protected
role of the FPC
regulates the risks in banking and ensures the financial system is stable
reasons why a bank might fail
risky loans
when value of liabilities is higher than the value of assets
poor credit of borrowers
risk involved with long term loands and short term borrowing
-lose money on investment
-insufficient funds in vault
-unable to provide depositers money when demanded
what is moral hazard
engaging in riskier behaviour with insurance than they would without it, because it makes the borrower less likely to pay
what is systemic risk
the damage on the economy or financial market e.g the risk of a collapsed bank
what is the liquidity ratio used to determine
how able a company is to pay off short term loans. the higher the liquidity ratio the greater the safety market of the bank
what is the capital rato
a comparison between the equity capital and the risk weighted assets of a bank, determined by the financial strength of the bank
what is equity capital
the amount of money collected by owners of firms in exchange for a portion of shares of a company
main functions of a commercial bank
accept deposits - fixed or demand deposits
usually have rate of interest return on
provide loans - create credit
investment of surplus funds e.g. government bonds and treasury bills to earn a return
liabilities are made up of…
cash, deposits, , borrowing nd reserve fundsa
assets are made up of …
cash, securities and bills, loans and investments
function of CB - monetary stability
ensure stable prices and confidence by meeting the inflation target
difficult since 2008 crash
function of CB - financial stability
overseeing efficient flows of money and savings and confidence in financial intermediaries
depositors need to know that their savings are safe an that banks are lending to others responsibly
