QE & Financial Stability

Question 1

Define Quantitative easing

Answer 1

This is used by banks to help to stimulate the economy when standard monetary policy is no longer effective.

QE is a method to pump money directly into the economy

Question 2

How is quantitative easing used

Answer 2

Quantitative easing is used to boost demand by injecting more money into the economy, normally used when interest rates are low and demand is not growing, quantitative easing should then cause increased investment and demand in the economy.

Question 3

What are the risks of using QE

Answer 3

Increased rate of inflation, if the injection of QE is larger than the rate of economic growth this can cause inflation to rise at an alarming rate.

Large-scale QE programs can put downward pressure on the value of a country’s currency relative to other currencies.

Causes income inequality - Benefitting individuals with assets

Question 4

Define reverse QE

Answer 4

Reversing QE - ‘quantitative tightening’, or QT. It raises interest rates which lowers inflation. But the size of this impact depends on the economic circumstances of the time.

Question 5

Define Direct intervention

Answer 5

Central Bank Intervention refers to the measures taken by the central bank of a country to affect the value of its own currency in the foreign exchange market.

Question 6

why does a central bank intervene in the foreign exchange market

Answer 6

To stabilise the exchange rate

To control inflation

To boost exports

Question 7

Define financial sector

Answer 7

Financial sector - (everything to do with banks, shares, bonds and so on) is vital to the smooth running of any major economy

Question 8

What is the Impact of UK financial sector on economy

Answer 8

Job creation. The finance sector has created highly paid jobs for those with the relevant skills and qualifications.

Wage inequality. The finance sector is one reason for growing wage inequality in the UK.

Export earnings. The finance sector is an important source of export earnings and economic growth.

Comparative advantage. The UK’s current comparative advantage is currently in finance.

Question 9

Define asset bubbles

Answer 9

In the financial sector, we often see ‘market bubbles. This occurs when assets such as house or shares rise rapidly and become over-valued. When the ‘bubble’ bursts, prices then fall rapidly.

Question 10

How asset bubbles occur

Answer 10

• Over-confidence, If an asset (such as housing) rises in price, people think this is a very good investment and so buy to try and benefit from rising house prices.
• Short-term profit. Asset bubbles create incentives for people to look for short-term profit from rising asset prices.
• Excessive QE causing high asset prices

Question 11

Problems with asset bubbles

Answer 11

• Falling house prices leads to a negative wealth effect – with a decline in their wealth, consumers tend to cut back on their spending
• Falling house prices can also lead to bank losses, banks then reduce lending to other firms in the economy.
• It can lead to job losses in construction.

Question 12

How does the government avoid asset bubbles

Answer 12

To avoid asset bubbles and other financial problems, regulation of the finance sector is important for maintaining macroeconomic stability.

Question 13

What is the purpose of legislation in the financial sector

Answer 13

• Avoid market bubbles. Asset bubbles can be destabilising causing large swings in the value of people’s wealth.
• Prevent bank collapses. Financial regulation seeks to ensure a stable banking sector so that investment funds are not adversely affected.
• Minimise excess risk taking. Private banks may take risky decisions in pursuit of short-term profit and ignore the possibility of bank losses.