Unit 7 - The Treasury and Economics Flashcards
What is the credit crunch and where did it start?
The credit crunch is where the banks do not have the money to lend and may even be insolvent. It began in the USA with irresponsible mortgage lending to people who could not afford to repay the loans.
How did the Bank of England and the Labour Government respond to the financial crisis?
The Bank of England cut interest rates and pumped money into the banks, so that they had money to lend. The Labour Government nationalised or part nationalised the banks that were in trouble, cut taxes and increased public spending to stimulate demand and keep people in work.
Why was the UK disproportionately hit by the financial crisis?
The UK was disproportionately hit because banking and financial services play a much greater part in the economy than in most other countries.
What is meant by the term deficit and how can it be addressed?
The deficit is the amount that expenditure exceeds income. It can be addressed by either cutting expenditure or increasing taxes, or a combination of both.
How did the Coalition Government decide to tackle the deficit? What has been the main impact on the people of the UK and public services? How successful were the policies in addressing the deficit?
The Coalition Government decided to reduce 80% of the deficit by cuts and 20% by increased taxes. This has had a major impact on everybody as it heralds an age of austerity. Public services, both those administered by central and local government, have witnessed massive cuts. Previously protected budget areas such as adult and children’s services were targeted by town hall chiefs desperate to bring their budgets down. Despite the size of the cuts, the deficit was not removed.
In outline, what is meant by inflation, how is it measured and why is it dangerous? Is inflation currently an issue in the UK?
Inflation means a general rise in prices. It is measured by one of two indexes – Consumer Prices Index and Retail Prices Index. Inflation is dangerous because it can cause a serious increase in unemployment. It has a disproportionate impact on those on fixed incomes (pensioners).
What is a recession and how may it be caused?
A recession is a downturn in the economic cycle and will be reflected by a drop in demand for goods, a consequential drop in output and a rise in unemployment. It can be the result of rampant inflation; overzealous deflationary policies; an external shock – credit crunch.
Name two important economic indicators that can be used to indicate the state of a country’s economy.
Key economic indicators would be GDP / GNP / Gross National Income; balance of payments / the current account (balance of trade and invisible balance); unemployment rates.
What would be the main advantages and disadvantages to the British economy in a drop in the value of the £?
Advantages would be that exports would be cheaper and should increase, foreign tourism should increase and this would benefit the leisure and retail industries, unemployment should also drop. Disadvantages – imports, especially food and raw materials (including fuel) would be more expensive which would be inflationary. (However, this may encourage the purchase of home produced goods and reduce unemployment). Foreign holidays would be expensive (stay-at-home holidays!).
How would an increase in the value of the £ impact on the UK economy?
Up to 2015 the value of the £ increased, in particular against the euro but also against the US dollar. This has made imports cheaper, especially fuel which is priced in dollars, but also food, raw materials and foreign holidays. This goes someway to explain deflation (drop in prices) but it is not all good news as an increase in the value of £ makes UK exports more expensive and we need to export. To do this we will have to become more productive – i.e. reduce the cost of producing the goods by investing in new plant or machinery, which may lead to an increase in unemployment. In 2016 the EU referendum triggered a fall in the value of the £ against both the US dollar and the euro which made UK products cheaper abroad but increased the cost of raw materials and products from overseas in the UK. The current indecision in regards to Brexit cause fluctuations in markets and the value of the pound.
What is a market economy?
A market economy is one that is based on the economic “laws” of supply and demand. These state that demand for goods will depend on the price of the goods. Generally, the cheaper the goods, the greater the demand. Conversely, the supplier of the goods will be motivated by the price that can be obtained for the goods – the greater the profit, the more that will be produced.
Hence in a market economy, price determines:
• what goods and services are provided;
• their quantity;
• the price for which they are sold.
What are the public and private sectors?
The public sector refers to the sector run by the state – i.e. government departments, local government, universities, state enterprises. The public sector should provide efficient and adequate services.
Any borrowing by this sector counts towards the Public Sector Net Cash Requirement (PSNCR).
The private sector refers to organisations which are privately owned – companies, partnerships, etc.
What is inflation and what are its causes and consequences?
Inflation is a state of affairs where there is an increase in the general level of prices and as a result the purchasing power of money falls.
Consequences of inflation are severe:
• People can buy less with their money and so the demand for goods drops; output drops since there is no point making goods that people will not buy; and unemployment rises.
It hits pensioners and those on fixed incomes hardest. Their living costs are going up but their income remains the same. Currently, to make things worse any savings they have in the bank are making next to nothing because interest rates are at rock bottom. Fortunately, inflation today is exceptionally low, although there are indications that it is beginning to rise.
• Exports may be hit if we have high inflation and other countries do not. Our goods and services will be expensive, so consumers abroad will not buy them. Our consumers will buy foreign goods if they are cheaper. Result – more unemployment.
Causes of inflation:
• Demand pull – if there is a major increase in demand for goods, the price of the goods will rise because the producers can see that more money can be made. That is why governments are always concerned by Christmas spending binges.
• Cost push – if there is a rise in the cost of producing the goods, the price will rise. The reasons for the increase, may be wage demands or a rise in the cost of raw materials, including energy.
• Rise in the money supply – putting this simply it means if the government consistently spends more money than it raises in taxes, the result will be inflation.
What are CPI and RPI?
Consumer Price Index and Retail Price Index are measures of inflation.
The average price of a basket of goods and services is recorded each month and compared with the price for the same basket in the previous month / year. If the price has gone up by 0.5% over the month, it will be reported the inflation rose this month by 0.5%. If it has gone up by 5%, compared with the previous year – the annual inflation rate is 5%.
The CPI and RPI are two slightly different baskets of goods and services. The consumer prices index, the preferred government index, excludes housing costs and traditionally is lower than the retail prices index.
What is deflation and what may it involve?
Deflation is both a policy and a state of affairs where prices fall.
The policy is used to combat inflation and may involve:
• raising interest rates – so that people and businesses have less to spend, leading to a drop in demand and a consequential fall in prices.
• raising taxes – so that people and businesses have less to spend leading to a drop in demand and a consequential fall in prices.
• cutting public spending – if the public sector has less to spend, demand for goods that they or their employees would want will drop and so prices will fall.
The problem is that since this all leads to a drop in demand, it will always lead to a rise in unemployment.
