Chapter 2 - The Economic Environment

Question 1

Who has the role of reducing trade barriers?

Answer 1

The World Trade Organisation promotes the growth of free trade between economies. It is called on to arbitrate when disputes arise.

Question 2

What are the two main stabilisation policies used by government/central banks to reduce the impact of fluctuations in economic activity? And how do they work?

Answer 2

1) Fiscal Policy - making adjustments using government spending and taxation2) Monetary Policy - making adjustments using interest rates and the money supply

Question 3

Who influenced a nation’s currency through activists such as intervention in the currency markets?

Answer 3

Central banks not government

Question 4

Who sets the official short term rate of interest?

Answer 4

Central banks not government

Question 5

What is the primary role of the Monetary Policy Committee and in what organisation do they sit in?

Answer 5

They sit in the Bank of England (central bank) and they determine the interest rate decisions (setting the base rate - short term interest rate) with the aim of ensuring inflation is hitting the target set by the Chancellor of the Exchequer (government).They also perform QE

Question 6

What 3 vital functions does preserving the financial stability have on the financial system?

Answer 6

1) helps to provide a mechanism for paying for goods and services 2) intermediate between savers and borrowers3) insuring against and dispersing risk

Question 7

In England, who manages the national debt and in which organisation do they sit?

Answer 7

Debt Management Office is part of government not part of the Bank of England.

Question 8

What is the role of the Financial Services Compensation Scheme and which organisation does it sit (in England)?

Answer 8

It provides a depositors protection scheme for bank deposits - it sits in the BoE

Question 9

How is the Fed run and managed? What is the FOMC?

Answer 9

A) Fed comprises of 12 regional Fed Reserve Banks each providing liquidity to the banks regions.B) The Fed is governed by 7 people appointed by the presidentC) FOMC is the Federal Open Market Committee - 7 people above and 5 of the 12 regional body presidents (of the 5 - the NY president is permanent the other 4 rotate)

Question 10

What is credit creation and what can it lead to? How is it regulated?

Answer 10

1) Lenders borrow (credit), and banks create money2) Lenders spend on credit and give money to ppl.3) Those people deposit4) Banks use the deposit to create creditUnregulated credit/money supply leads to inflation: too much money chasing too few goods.96% of all money is from credit supply, 4% is cash.Regulated by BoE setting interest rates and imposing capital ratios (ie. How much or the % of cash you have to keep)(1/reserve requirement = credit: e.g 10% cash held is 10 times in credit value that the initial cash lump had in value)

Question 11

Why causes inflation to rise?

Answer 11

Excess demand in the economyScarcity of workers and resources (reduced supply)Rapidly increasing government spending

Question 12

What are the negatives of inflation?

Answer 12

Business continually have to update pricesSalary value erodes including future value of pensions and investments (includes those on fixed salaries)Exports are less competitive

Question 13

What are the positives to inflation?

Answer 13

Rising house prices create a feel good factorDebt decreases in value (borrowers and national debt)

Question 14

What is CPI?

Answer 14

Consumer Price indexExcludes mortgage interest payments and other housing costsUsing to compare against the rest of Europe (standard)Vs RPIX = RPI excluding mortgages interest payments but not the exact same sample as CPI

Question 15

What’s is RPI?

Answer 15

Retail price indexIncludes mortgage and rent paymentsThis is used in indexed linked giltsRPIX - excludes mortgage interest payments

Question 16

What is GDP and what does it contain?

Answer 16

Measures countries output calculated quarterly using expenditure basis.GDP = consumer spending + government spending + investment + exports - imports.Note. Includes production of foreign-owned factors produced in the UK. It excludes production of UK-owned factors of production held abroad

Question 17

What is a balance of payment deficit?

Answer 17

UK imports more than it exports.It is a measure for the transactions between the UK and the rest of the world.Includes current (visible and non visible trade) and capital account (any other capital eg from profits).

Question 18

What is the trade balance?

Answer 18

Comprises of:1) visible trade balance = value of imported goods - value of exported goods2) invisible trade balance = imported services - exported servicesExcludes dividends

Question 19

What is the current account?

Answer 19

Values of goods and services that flow into and out of a country. It also includes receipts of dividends from overseas and remittances from nationals abroad

Question 20

What is the capital account?

Answer 20

International capital transactions related to investment in business, real estate, bonds and stocks(Eg. If a company exports more than it imports, it has spare capital for investments the capital part is the capital account)

Question 21

What is the PSNCR?

Answer 21

Public Sector Net Cash Requirement= government expenditure - government income.

Question 22

What are the effects of unemployment?

Answer 22

Indicates low demand for goodsReduced tax income for government and increased social security payments

Question 23

What Key Economic Indicator is used to measure the changes in costs?

Answer 23

CPI (consumer price index ex. Mortgage interest) and RPI (retail price index inc. mortgage interest) measures inflation

Question 24

What Key Economic Indicator is used to measure the countries output?

Answer 24

GDP (consumer spending + government spending + investment + exports - imports)

Question 25

What Key Economic Indicator is used to measure all transactions with the rest of the world?

Answer 25

Balance of payments (deficit - imports more than exports) - some of both:1) Current account = Trade balance (value of exported goods and services - imported) + other goods and services (factors income [= Income for locals on foreign investments - foreigners investor income on local investments] and financial transfers [people working in one country and sending it to another country]) 2) Capital account = internal capital transaction, net change in foreign investments (eg. Business investments, real estate, bonds and stocks)

Question 26

What Key Economic Indicator is used to measure the government income - spending?

Answer 26

PSNCR- public sector net cash requirement

Question 27

What are the different types of economies? (Who determines the allocation of resources)

Answer 27

1) State controlled - state decides what is produced and how it is distributed2) Market economy - resources are allocated by supply and demand. Businesses product good and services to meet demands from customers. People compete for jobs and companies compete for customers3) Mixed Economy - government provides a welfare system and other areas (defence, education, public transport, health and police) paid for by tax collections. And there is some market economy4) Open Economy - countries economic relationship with outside countries. In an open economy their a few barriers to trade or controls over FX. The World Trade Organisation exist to promote the growth of free trade between economies.

Question 28

What is the role of the ECB?

Answer 28

It is responsible for price stability in the eurozone. CPI inflation target of 2%.It wasn’t the lender of last resort (it was the national central banks job), however after 2012 this changed

Question 29

What’s is the difference in GDP vs GNP?

Answer 29

GDP = Includes production of foreign-owned factors produced in the UK. It excludes production of UK-owned factors of production held abroadGNP = national therefore the opposite to above

Question 30

What is real GDP?

Answer 30

After inflation is taken out used to see the trends in GDP analysis

Question 31

What effect will a balance payment deficit have on currency?

Answer 31

Deficit implies imports (ie everything else seems cheap because its strong currency makes everything look cheap) more than exports. This isn’t sustainable so it will balance up by depreciating the value of the currency

Question 32

What’s the difference between government deficit and debt?

Answer 32

Debt is the accumulated national debtDeficit is the shortfall on the year