Unit 1 - Topic 2 - Economic policy and financial regulation

Question 1

What is inflation?

Answer 1

A general rise in prices, resulting from ‘too much money chasing too few goods’. In more formal economic terminology, it can be defined as a situation where the rate of growth of the money supply is greater than the rate of growth of real goods and services.

Question 2

What is disinflation?

Answer 2

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

Question 3

What is deflation?

Answer 3

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 4

What are the key 4 macroeconomic objectives?

Answer 4

1) Price stability
2) Low unemployment
3) Balance of payments equilibrium
4) Satisfactory economic growth

Question 5

What is RECESSION?

Answer 5

A significant decline in economic activity over a sustained period. Technically, it is two consecutive quarters of negative economic growth as measured by a country’s gross domestic product (GDP).

Question 6

What is GROSS DOMESTIC PRODUCT (GDP)?

Answer 6

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 7

What is the CONSUMER PRICES INDEX?

Answer 7

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.

Question 8

What is the average annual rate of inflation set by the government and what is the maximum divergence % either side?

Answer 8

2% with 1% divergence

Question 9

What are the two major types of policy used by governments in their attempt to achieve long‐term economic objectives?

Answer 9

monetary policy and fiscal policy.

Question 10

Who retains the right to give instructions to the Bank of England regarding its monetary policy in ‘extreme economic circumstances’?

Answer 10

The Treasury (otherwise the Bank acts independently of the government.)

Question 11

Who sets the Interest rates?

Answer 11

Set by the Bank of England’s Monetary Policy Committee (MPC).

Question 12

What are DIRECT TAXES?

Answer 12

Apply to individuals and their assets (income tax, capital gains tax, inheritance tax, National Insurance).

Question 13

What are INDIRECT TAXES?

Answer 13

Applied to goods and services at the time they are purchased (eg VAT, stamp duty).

Question 14

Definition of Balanced budget?

Answer 14

Effect on economy is neutral – amount taken in tax is put back into public spending

Question 15

Definition of Budget surplus?

Answer 15

Amount taken in taxation is greater than amount put back in to public spending – the economy contracts

Question 16

Definition of Budget deficit?

Answer 16

Public spending is greater than amount taken in taxation – economy expands

Question 17

What is FISCAL POLICY?

Answer 17

The adjustment of levels of taxation and public spending in a way that is intended to achieve the government’s macroeconomic objectives

Question 18

What is Monetary policy?

Answer 18

Acts on the economy as a whole, currently through changes in the general level of interest rates

Question 19

The European Union has issued a new regulation. This means that each member state:

a) has the choice whether or not to adopt the regulation.
b) must pass legislation to implement the regulation within two years.
c) is bound by the regulation in its entirety regardless of existing legislation.
d) has the choice of how to adopt the regulation’s objectives.

Answer 19

c) is bound by the regulation in its entirety regardless of existing legislation.

Question 20

What are the two main types of European legislation that impacts on the UK financial industry?

Answer 20

regulations and directives

Question 21

What are the 2 main regulatory bodies in the UK ?

Answer 21

Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA).

Question 22

What are the 5 levels of regulatory oversight in the UK?

Answer 22

Level 1 - European legislation
Level 2 - Acts of Parliament
Level 3 - Regulatory bodies
Level 4 - Policies/practices of the financial institution
Level 5 - Arbitration schemes (eg Financial Ombudsman Scheme)

Question 23

What is meant by a ‘macroeconomic objective’?

Answer 23

An objective that relates to the economy as a whole, rather than to a specific sector or individual company.

Question 24

What is a potential negative consequence of expanding economic growth to reduce unemployment?

Answer 24

Measures taken to expand the economy (eg reducing interest rates and taxation) increase the demand for goods and services, which is likely to result in a rise in inflation.

Question 25

All governments aim to achieve zero inflation. True or false?

Answer 25

False. They aim to keep prices stable, but seeking to reduce inflation to zero is likely to increase unemployment.

Question 26

What is the UK government’s inflation target and how is it measured?

Answer 26

The UK government’s inflation target is 2 per cent with a maximum divergence either side of 1 per cent. It is measured by the Consumer Prices Index.

Question 27

Disinflation means that:

a) prices are rising faster than previously.
b) prices are falling.
c) prices are rising but more slowly than previously.
d) prices are staying the same.

Answer 27

c) Prices are rising but more slowly than previously.

Question 28

In June, the Monetary Policy Committee (MPC) decides to raise the Bank rate by half a percentage point. In August, Paul and Amanda’s mortgage payments increase. Explain how these two events are likely to be linked.

Answer 28

Paul and Amanda must have a variable‐rate mortgage, so the amount they pay each month is likely to rise and fall broadly in line with changes in the Bank rate.

Question 29

Which of the following economic measures taken by a government would not help to achieve a budget surplus?

a) Increasing taxation.
b) Increasing public spending.
c) Reducing public spending.

Answer 29

b) Increasing public spending. To achieve a budget surplus a government must cut public spending, raise taxes, or both.

Question 30

A new piece of EU legislation is being introduced. It is being implemented at the same time and in exactly the same way across all member states. This indicates that the legislation is in the form of:

a) a directive.
b) a regulation.

Answer 30

A regulation. Member states have flexibility in the way they introduce directives.

Question 31

Which EU body is responsible for monitoring the financial system for systemic risk and taking steps to reduce it?

Answer 31

The European Systemic Risk Board (ESRB).