Topic 2: The Role Of The Government

Question 1

What is the key difference between EU regulations and directives?

Answer 1

Regulations - General Application, are binding in their entirety and directly applicable in all member states.

Directives - Binding on each member state within a certain time frame, it is up to each nation to decide how they are achieved.

Question 2

What are the four main freedoms specified in the Single European Act that came into force in 1987?

Answer 2

1. Freedom of Movement for Persons - All EU citizens have the right to employment and to reside in any member state.
2. Freedom Of Movement for Goods - No custom duties, measures, or restrictions.
3. Freedom of Movement for Capital - No restrictions on Capital Investments.
4. Freedom to Provide Service - Right to provide banking/insurance services in all member states.

Question 3

What did the 1979 Cassis De Dijon judgement establish?

Answer 3

The European Court of Judgement, Cassis De Dijon, established the principle of mutual recognition by member states of national rules of individual states.

Question 4

Briefly describe the Five Tiers of the UK regulatory system.

Answer 4

1. First Level - EU Legislation that impacts on the UK financial industry. Regulations and Directives.
2. Second Level - Acts of Parliament that set out what can and cannot be done.
3. Third Level - Regulatory Bodies that monitor and issue rules to make legislation work.
4. Fourth Level - Policies and Practices of the financial institutions themselves.
5. Fifth Level - Customer Complaint, Ombudsman.

Question 5

Complete this table:

                                              Pound Rises         Pound Falls

Cost of Exports
Cost of Imports
Exporter Firm Profits
Exporter Firm Share Price
Importer Firm Profits
Importer Firm Share Price

Answer 5

Complete this table:

                                              Pound Rises         Pound Falls

Cost of Exports + -
Cost of Imports - +
Exporter Firm Profits - +
Exporter Firm Share Price - +
Importer Firm Profits + -
Importer Firm Share Price + -

Question 6

What is the MPC inflation rate target? What happens if that target is missed?

Answer 6

The MPC (Monetary Policy Committee) has a target inflation rate of 2%.

The MPC meets 8 times a year to decide on the Bank Rate (Rate of 14-day Gilt Repos)

If inflation is more than 1% above or below target, the governor of the bank must write to the Chancellor of the Exchequer explaining why and also what actions will now be taken.

Question 7

What is the difference between disinflation and deflation?

Answer 7

Disinflation - Falling inflation rates ie. 4% to 2%

Deflation - Sustained price reductions ie. £10 to £8 item

Question 8

What is the real rate of interest if the nominal interest rate is 4.5% and inflation is 3%?

Answer 8

Formula for Real Interest Rate:
(1 + Nominal Rate) / (1 + Inflation Rate) - 1

For given example:
(1 + 0.045) / (1 + 0.03) - 1 = 0.01456 = 1.46% Real Rate

Question 9

What is the difference between an Expansionary and Contractionary Fiscal policy?

Answer 9

Expansionary Fiscal Policy - Stimulate the economy by Decreasing Tax and increase public spending. Tax take will reduce so government may have to borrow by issuing Gilts/Treasury Bonds.

Contractionary Fiscal Policy - Reduce demand and economic spending by Increasing Tax. This should help lower inflation. Government hopes to get a budget surplus.

Question 10

What is the key component of Monetary Policy?

Answer 10

Nowadays, Monetary Policy refers mainly to Interest Rates.

Question 11

The government have decided to discourage imports and encourage exports. What effect would it hope it would have on the country’s balance of payments?

Answer 11

Balance of Payments is a record of a country’s trade with the rest of the world.
Money IN = Credit. Money OUT = Debit.

A deficit can arise when a country spends more foreign currency to buy goods than it receives from exports.

A deficit can be corrected by discouraging imports and encouraging exports.

Question 12

What is Fiscal Policy? What are the three main components?

Answer 12

Fiscal Policy (Budgetary Policy) is the process by which the government attempts to influence the level of economic activity.

This is achieved through 3 ways:

1. Government Spending
2. Taxes
3. Borrowing

Question 13

What are the main economic objectives of modern government?

Answer 13

1. Price Stability - Low and controlled rate of inflation (2-3% target).
2. Low Unemployment - Expand the economy, give fully employed a good standard of living, boost tax revenue and keep state welfare down.
3. Balance of Payments Equilibrium - Balance imports and exports for a stable economy.
4. Economic Growth - Increase output of economy over time.

Question 14

What are the two main functions of the government in financial markets?

Answer 14

1. Managing the economy - Ensure financial markets operate efficiently and effectively. Investors, lenders, and borrowers have the confidence to carry out transactions.
2. Regulation - Ensure appropriate standards of ‘behaviour’ and consumer protection are upheld.