Topic 2: Economic policy and financial regulation

Question 1

What is the difference between macroeconomic and microeconomic?

Answer 1

Macroeconomic objectives
because they concern economic aggregates, ie totals that give us a picture of the economy as a whole, as opposed to microeconomic objectives that concern
individual firms or consumers.

Question 2

What are the key 4 macroeconomic objectives?

Answer 2

1. Price Stability - Involves low and controlled rate of inflation. Zero Inflation is not desirable because moderate inflation can stimulate investment.
2. Low Unemployment - expanding the economy so that there is more demand for labour, land and capital.
3. Balance of payments equilibrium -a situation in which expenditure on
   imports of goods and services and investment income going abroad is
   equal to (ie in equilibrium with) the income received from exports of goods
   and services and the return on overseas investments.
4. Satisfactory economic growth - the output of the economy is growing in
   real terms over time and standards of living are getting higher.

Question 3

The 4 key macroeconomic objects tend to fall into two pairs?

Answer 3

• policies to reduce unemployment will also boost growth;
• measures to reduce inflation will also help to improve the balance of
  payments.

Question 4

What is Inflation?

Answer 4

The rise in prices of goods and services over time.

Question 5

What is Deflation?

Answer 5

A general fall in the price of goods and services. In other words, the inflation rate is below zero per cent – a negative inflation rate.

Question 6

What is Disinflation?

Answer 6

A fall in the rate of inflation, ie prices are still rising, but less quickly than they were.

Question 7

What is a recession?

Answer 7

A country’s gross domestic product (GDP) falls in two consecutive quarters.

Question 8

What is Gross Domestic Product (GDP)?

Answer 8

GDP is a measurement of a country’s overall economic activity. Technically
it is the monetary value of all the goods and services produced within the country (ie ‘domestically’) in a given period, eg one year.

Question 9

What are the four main phases economies go through?

Answer 9

Recovery and Expansion -Interest rates, inflation and unemployment are low.
Consumers have money to spend. Demand for goods
and services rises, pushing prices up. Share prices
improve as businesses flourish.
Boom -To prevent the economy from overheating, the Bank of England may intervene by putting up interest rates to
control consumer spending and dampen inflation.
Contraction or slowdown -Once the interest rate rises start to bite, consumer
spending falls. Demand for goods and services falls,
profits fall (as do share prices) and unemployment
rises. Inflation slows down.
Recession -As the economy heads towards its lowest level of activity, the Bank of England may intervene to reduce interest rates in a bid to stimulate demand and set the economy on the path back to recovery.

Question 10

What is the Consumer Price Index (CPI)?

Answer 10

A measure of the change in price of a ‘basket’ of consumer goods and
services over a period.

Items to be
included in the ‘basket’ are reviewed regularly to ensure it provides an
accurate reflection of consumer spending. It is the equivalent of the Harmonised Index of Consumer Prices
(HICP) used within the eurozone.

Question 11

What is Monetary Policy?

Answer 11

Controlling the supply of money in a country to manage inflation, mainly through interest rates. Less money in the economy will restrict spending to reduce inflation. Increasing the amount of money available will increase spending and inflation.

Question 12

What is Bank Rate?

Answer 12

The rate at which the Bank of England lends to other financial institutions.
In this text the term ‘Bank rate’ is used, but you might also see it written
‘Bank Rate’ or referred to as ‘base rate’.

Question 13

What is Inflation Target?

Answer 13

The level of inflation that economists judge is appropriate to keep the
national economy functioning efficiently. As we have seen, in the UK the
inflation target is 2 per cent, as measured by the Consumer Prices Index,
with a 1 per cent maximum divergence either way. The Bank of England
has responsibility for achievement of the government’s inflation target. Current and predicted future levels of inflation are a key consideration
in setting the Bank rate.

Question 14

Who sets Interest Rates and how often do they meet each year?

Answer 14

The Bank of England’s Monetary Policy
Committee (MPC).

The MPC usually meets eight times a year over three days to set the interest rate that it judges will enable the inflation target to be met.

Question 15

What is the disadvantage of variable interest rates (such as mortgages)?

Answer 15

It is difficult for
borrowers to budget for the likely future cost of repaying their loan. Sudden,
large interest rate increases can lead to borrowers being unable to make their
mortgage repayments; in the worst cases, some borrowers may even lose their homes if the lender has to take possession.

Question 16

What is the disadvantage of fixed rate mortgages (such as mortgages)?

Answer 16

• There is a danger that a borrower will lose out if the variable rate falls and
  they are locked into a higher fixed rate.
• There is normally a penalty for paying off the mortgage within the fixed-rate
  period, too, in order to protect the lender. This is because the funds used to
  subsidise fixed-rate loans are normally raised in the money markets on terms
  that bind the lender to the medium/long term.

Question 17

What is Fiscal Policy?

Answer 17

The use of taxation and government borrowing and spending to affect economic activity, and can also influence the money supply, although monetary policy is the main tool for money supply.

Question 18

Explain Balanced Budget, Budget Surplus and Budget Deficit?

Answer 18

Taxation and Public Spending are the same = Balanced Budget

Taxation is more than Public Spending = Budget Surplus

Public Spending is more than taxation = Budget Deficit

Question 19

What is Public Sector Net Cash Requirement?

Answer 19

A government that has a deficit must borrow to finance it. The public
sector net cash requirement (PSNCR) is a cash measure of the public sector’s short-term net financing requirement.

Question 20

How can Fiscal Policy (i.e taxation) can have a macroeconomic effect?

Answer 20

Increase In taxation - less disposable income - less spending - less demand for goods and services - Inflation falls

Reduction in taxation - more disposable income - more spending - high demand for goods and services - Inflation Rises

Question 21

Changes in taxation affect the market for financial services and products in
two main ways?

Answer 21

• Increased general taxation reduces the amount of money available for
  investment or to fund loan repayments.
• Tightening of the taxation regime in relation to particular products or
  activities makes them less attractive to investors. For example, in April
  2016 a stamp duty land tax supplement was introduced in respect of the
  purchase of second properties. This followed concern that first-time buyers
  were being priced out of the housing market as a result of demand from
  buy-to-let landlords.

Question 22

Explain EU laws in relation to Regulations?

Answer 22

• Have general application.
• Are binding in their entirety, both in respect of what is to
  be achieved and how it is to be achieved.
• Are directly applicable in all member states (unless
  particular states have specific dispensation).

Question 23

Explain EU laws in relation to Directives?

Answer 23

• Are binding upon each member state to which they are addressed as to the result to be achieved.
• Each member state has discretion as to how they go about achieving the stated aim of the directive.
• The directive objectives must be achieved within a specific timescale (typically two years) but exactly how they are achieved is left to the authorities within each member state
  to determine.

Question 24

What is The European System of Financial Supervision?

Answer 24

In response to the financial crisis of 2007–09, the EU set up the European
System of Financial Supervision (ESFS); its aim is to ensure consistent financial supervision across the member states.

Question 25

The European
Supervisory Authorities (ESAs) are the:

Answer 25

• European Securities and Markets Agency (ESMA);
• European Banking Authority (EBA); and
• European Insurance and Occupational Pensions Authority (EIOPA).

Question 26

What are the 7 aims of European Supervisory Authorities (ESA)?

Answer 26

1. creating a single EU rule book by developing draft technical standards,
   which will then be adopted by the European Commission as law;
2. issuing guidance and recommendations with which national supervisors
   and firms must comply
3. investigating national supervisory authorities that are failing to apply, or
   are in breach of, EU law;
4. in a crisis, providing EU-wide co-ordination and, if an emergency is declared,
   making decisions that are binding upon national supervisors and firms;
5. mediating in certain situations where national supervisory authorities
   disagree and, if necessary, making decisions that are binding on both
   parties to ensure compliance with EU law;
6. conducting reviews of national supervisory authorities to improve
   consistency of supervision across the EU;
7. considering consumer protection issues.

Question 27

What is the role and responsibilities of European Systemic Risk Board?

Answer 27

Its role is to prevent and mitigate systemic financial risk across the EU. Its responsibilities include:
- identifying and prioritising risks;
- issuing warnings and recommendations and monitoring their follow-up;
- co-operating with other members of the ESFS; and
- co-ordinating action with other international financial organisations, such
as the International Monetary Fund (IMF).

Question 28

What is the Single Supervisory Mechanism?

Answer 28

The Single Supervisory Mechanism (SSM) is the name for the mechanism by
which the European Central Bank holds responsibility for the supervision and
monitoring of banks in EU member states.

Question 29

What are the levels of regulatory oversight in the UK?

Answer 29

1. Acts of Parliament (eg financial services and markets act 2000, including onshored EU legislation).
2. Regulatory Bodies (monitoring regulation and issuing rules and requirements).
3. Policies/ Practices of the financial institution (a banks own procedures).
4. Arbitration Schemes (eg Financial Ombudsman Scheme).