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A-Level Economics : Macroeconomics > Chapter 12 : Financial markets and monetary policy > Flashcards

Chapter 12 : Financial markets and monetary policy Flashcards

(66 cards)

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1
Q

What is the difference between assets and liabilities? Give examples.

A

Assets are things which people or organisations own. Whereas liabilities are things which people or organisations owe. Example of an asset: House
Example of a liability: Loan

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2
Q

What are the functions of money?

A
  • Medium of exchange
    • Trading or exchanging goods and services for the payment of money
  • A store of value or wealth
    • Money is an asset people own with a value - what is it worth
  • Unit of account
    • A standard of deferred payment and a measure of value - This means that products are given a money value and compared to other prices but individuals may have no intention of buying or selling immediately until later
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3
Q

What are the characteristics of money?

A
  • Representative money
  • Token money
  • Commodity money
  • Barter
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4
Q

What is the money supply?

A

The money supply is the stock of financial assets with the function as money.

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5
Q

What are two types of the money supply?

A

Notes and coins and Bank accounts.

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6
Q

What is narrow money?

A

The part of the stock of money that is made up of liquid bank and building deposits and cash.

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7
Q

What is broad money?

A

The part of the stock of money that is made up of components of narrow money but also illiquid assets such as savings.

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8
Q

What is liquidity? Give an example.

A

The measure of how easily an asset can be converted into cash without the loss of value.
Ex. Cash

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9
Q

What is the difference between equity and debt?

A

Equity is all the financial and physical assets people own. Whereas debt is the financial liabilities people owe.

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10
Q

What are shares?

A

Shares are updated financial assets sold by companies to raise financial capital.

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11
Q

Who are shareholders?

A

Shareholders are people who buy shares in a company. They co-own the company and are able to vote on how to run the company.

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12
Q

What are bonds? Give examples.

A

Bonds are financial securities sold by governments and firms which are long-term forms of borrowing.
Ex. Corporate and Government bonds

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13
Q

What is a maturity date?

A

A date when bonds have to be paid by.

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14
Q

What is a coupon rate?

A

The fixed interest rate on a bond.

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15
Q

What is the money market? Give an example.

A

Financial market that provides short-term finances to individuals and firms.
Ex. Liquid assets

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16
Q

What is the capital market? Give examples.

A

A financial market that provides medium to long term finances to individuals and firms.
Ex. Shares and Bonds

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17
Q

What is the foreign exchange market? Give an example.

A

A financial market that trades currencies.
Ex. Forex

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18
Q

What is the difference between a spot and forward market?

A

SPOT = immediate
FORWARD = future
A spot market is a market in which the conversion of one currency to another happens immediately. Whereas a forward market is a market where there is an agreement to buy a foreign currency at a specified date in the future.

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19
Q

What is the inverse relationship between interest rates and bond yields?

A

As interest rates increase bond prices fall. As interest rates fall bond prices rise.

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20
Q

What is the formula to calculate yields?

A

Yield = Coupon rate/ Market price x 100

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21
Q

What is a commercial bank?
Give an example.

A

Banks that sell banking services to customers to make profit. Also known as ‘High-street banks’.
Ex. HSBC

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22
Q

What are the functions of a commercial bank?

A
  • Accept deposits from the public
  • Creating deposits - lending to customers
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23
Q

What is an investment bank?
Give an example.

A

Banks that provide financial advice to companies and other financial institutions to raise finance.
Ex. Goldman sachs

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24
Q

What are the functions of an investment bank?

A
  • Selling shares and bonds
  • Providing financial advice
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25
Why may banks operate as both commercial and investment banks?
To maximise profits and benefit from economies of scale.
26
What are the assets on a commercial banks sheet?
- Notes and coins - Investments - Bills - Advances - Balances of BoE - Fixed assets (bank buildings)
27
What are the liabilities on a commercial banks sheet?
- Long-term borrowing (bonds) - Short-term borrowing (loans) - Share capital - Customers deposits - Retained profits (reserves)
28
What is systemic risk?
The risk of the banking system breaking down because of interlinkage rather than the failure of an individual bank.
29
How do banks create credit? (7 steps)
1. Banks know that customers won't withdrawal all their deposits at the same time 2. Make deposits liquid into cash 3. Banks lend out deposits to borrowers who spend or deposit their money elsewhere in the banking system 4. As they are redeposited they can be lent out more (more credit is created) 5. The less cash banks have the more credit they can create 6. If everyone tries to withdraw their money at the same time this means the banks won't have money to meet demands 7. Can lead to a 'run on the bank' and so the fear of a collapse causes more withdrawals from customers
30
What are the objectives of a commercial bank?
1. Liquidity - Need enough money to let customers withdraw money 2. Profitability - Lending money earns interest which generates profits for shareholders 3. Security - Banks take risks when lending if borrowers don't repay their money
31
What are the conflicts between commercial bank objectives?
1. Banks borrow in the short- term and long-term but banks may not have money when they need it 2. Banks want to lend to to generate profit but lending money reduces liquidity as money could be tied somewhere else this is risky
32
What is profitability?
State of yielding financial gain.
33
What is security?
Secured loans (Mortgages) are less risky for banks than unsecured loans.
34
What is the central bank? Give an example.
The national bank that provides financial and banking services to the government. Also implement monetary policy and issues currency. Ex. Bank of England
35
What are the functions of the central bank?
1. Maintain financial stability 2. Help the government achieve macroeconomic stability
36
What is financial stability (function of CB)?
Monitors and checks banks are safe and stable and is the lender of last resort if the bank runs out of cash
37
What is macroeconomic stability (function of CB)?
Providing input on the MP so by achieving price stability it will be easier for other macro objectives to be achieved.
37
What is the monetary policy?
Monetary policy is an economic policy that is implemented by the central bank to control interest rates, influence the money supply through borrowing money.
38
What are the objectives of the monetary policy?
1. Key aims to achieve UK inflation target of 2% 2. Full employment and economic growth (ONLY IF IT DOESN'T CONFLICT WITH INFLATION RATE)
38
What is the monetary policy committee?
The part of the BoE that implements MP to try and hit targets set by the UK gov.
39
What are monetary policy instruments?
Tools such as interest rates to try and achieve MP objectives.
40
What are the factors that the MPC considers when setting the bank rate?
- Consumer spending and confidence - Business investment and confidence - Unemployment and labour market - Commodity prices - Exchange rates - Government spending & fiscal policy
41
What does a decrease in the bank rate lead to?
- Less saving - More consumption - Borrowing is cheaper - increase in AD - Increase in inflation
41
What does an increase in the bank rate lead to?
- Consumption decreases - Borrowing becomes expensive - More savings - Exchange rates rises - Exports fall - Mortgage payments rise - Less business investments - Lower demand pull inflation
42
What are the effects of the interest rate on other objectives?
- High interest rates lead to lower AD - Higher unemployment because of a decrease in spending - Rise in exchange rate leading to a decrease in exports - Lower short-term economic growth - Growth of supply-side of the economy
43
What is expansionary monetary policy?
The use of low interest rates to increase AD and shift it to the right.
43
What are the limitations of interest rates?
- Time-lag in effectiveness - Uncertain effects - Low interest rates may mean no further cuts in the interest rate - Changes in the interest rates may have to be large to be significant
44
What is contractionary monetary policy?
The use of high interest rates to decrease AD and shift it to the left.
45
What is the effect of interest rates on exchange rates?
1. An increase in interest rates leads to foreign investors buying the pound. This leads to a stronger pound and UK exports become more expensive and decrease and imports become cheaper and increase. This leads to a left shift in AD. 2. A decrease in interest rates leads to investors moving their money from the UK. This leads to the pound being weaker so UK exports become cheaper and increase but imports become more expensive and decrease. This leads to a right shift in AD.
46
What is conventional monetary policy?
Interest rates/ the bank rate
47
What is unconventional monetary policy?
1. QE 2. Forward guidance 3. Funding for lending scheme
48
What is quantitative easing?
When the BoE buys assets with money created electronically in the bank.
49
How does QE work?
TBC
50
Who benefits and who suffers from QE?
Benefits: - **Wealthy households** as asset prices rise - **House buyers** as mortgages are cheaper - **Governments** as there are lower costs of borrowing to finance deficits Suffers: - ** Poorer households** as they don't own a lot of assets - **Savers and people in pension schemes** as they have a lower return of savings
51
Was QE successful?
It helped prevent a depression and helped support the economy to fight a recession but it did have mixed results.
52
What is forward guidance?
When the MPC uses forward guidance to make it easier for individuals and households to plan their spending and investment decisions.
53
What is the funding for lending scheme?
Introduced in 2012 by the treasury and the BoE to boost bank lending and economic activity but it ended in 2018.
54
What is the difference between micro prudential and macro prudential regulations?
**Micro** is the identifying, monitoring and acting on risks for individual banks and firms. **Macro** is the identifying, monitoring and acting on risks which threaten the whole financial system of an economy.
55
What is the PRA?
Prudential regulations authority is an institution responsible for supervising individual financial institutions by setting standards for financial organisations to follow.
56
What is the FPC?
Financial Policy Committee is the institution responsible for identifying and removing systematic risks to the whole financial system of an economy. Ex. run on the bank
57
What is the FCA?
Financial Conduct Authority is an institution that aims to protect consumers, financial markets and promote effective competition.
58
Why do banks fail?
If they don't have sufficient liquidity as they make a bank vulnerable to a run on the bank.
59
What are moral hazards?
The tendency for individuals and firms once protected by a contingency to behave risky to make the contingency more likely to happen.
60
What is the difference between the liquidity and capital ratio?
Liquidity ratio is the ratio of lending to liquid cash. Whereas capital ratio is the ratio of how much a bank own to how much they're lending.
61
Explain the systemic risk that happened in 2007. (6 steps)
1. 2007 banks sold risky subprime mortgages to people with poor cred history 2. Banks stopped lending because they didn't trust each other as assets were worthless 3. This led to the credit crunch 4. Credit dried up which lead to a decrease in consumption and investment (collapse in AD) 5. Global recession happened so unemployment increased 6. Central banks and governments had to stop financial system from completely collapsing
62
How does an increase in interest rates lead to a decrease in AD?
- Higher IR reduces consumption - Higher IR reduces business investments - Change in the IR affects exports and imports through ER

A-Level Economics : Macroeconomics (6 decks)

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