Financial markets and monetary policy Flashcards
(17 cards)
1
Q
Money
A
- Functions = med of exchange, unit of acc, store of value, stand of def pay
- Char = acceptable, divisible, portable, scarce, divisible
- Money supply = narrow (SR deposits), broad (total)
- Equity = stakeholder cap
- Debt = external finance
2
Q
Financial markets
A
- Sections
–> Money (SR loans, LR govt borrowing, interbank lending)
–> Capital (financial assets)
–> Currency (spot, future)
3
Q
Bonds/yields
A
- Bonds = IOU’s, allow govt/firms to borrow from investors
- Govt bonds = raise money for govt
- Corp bonds = raise cap for production
- Incentive = very secure
- Treasury gilts = buy nominal value (£100)
- Coupon = fixed amount paid each year (£5)
- Maturity = get principal back (5 years)
- Market price = value on secondary market (£115)
- Yield = (coupon / market £) * 100
- Market price inverse to yield
4
Q
Phillips curve
A
- Inverse relationship between inflation and unemployment rate
- ↑unemp, ↓inflation = -ve output gap)
- ↓unemp, ↑inflation = +ve output gap
- LRPC = remain constant in the LR (self corrects)
- SR = prioritise certain objs, tradeoffs inevitable
- LR = policies to achieve all objs
- EAPC = expected inflation caused inflation to rise
5
Q
Commercial banks
A
- What = financial institutions, make money selling services to customers (public)
- Functions = take deposits, lend to borrowers
- How = interest>returns, service fees, brokerage %
- Balance sheet
–> Assets = cash, BoE reserves, I, advancements, fixed assets
–> Liabilities = deposits, borrowing
–> Capital = shareholder funds, retained profit - Objectives = profitability, liquidity, security (conflict)
6
Q
Investment banks
A
- What = work for firms/govt not public
- Functions = underwrite shares, trade shares/bonds, lend out, financial advisor, M&A advisor
- How = underwriting, advisory fees, trading, asset management
7
Q
Systemic risk
A
- Interdependence causes financial system to crash
- Commercial + investment banks take more risks
- Severe econ downturn
- Bank failure = recession, bailouts, unemp, lowY/output
- Run on banks = everyone withdraws money at once in panic
8
Q
Central bank
A
- Functions
–> Set bank rate
–> Regulate banks
–> Fin stability (bailouts, lender of last resort, liquidity assurance)
–> Manage currency
–> Policy research
–> Mon policy authority
–> Bank for govt/banks - Problems = moral hazard, insufficient liquidity, reg capture, bailouts unfair
9
Q
Monetary policy
A
- What
–> BoE instrument to control inflation via bank rate, money supply and exchange rate
–> Depends on = output gap, C/B conf, rate change - MPC
–> Set bank rate
–> Assess economy
–> Consider GDP, unemp, inflation, exchange rate, housing £, I - Expansionary (↓rate,↑AD)
–> ↑C = ↓S, ↑C, ↑Y, ↑GDP
–> ↑I = cheaper to borrow
–> ↑G = ↑spend, ↓interest
–> ↑X = ↓currency(↓M,↑X)
–> Pros = growth, ↓CA def, ↑I, ↓unemp
–> Cons = ↑inflation, ↑M (↑AD), liquidity trap, -ve for savers, time lags - Contractionary (↑rate,↓AD)
–> ↓C = ↓MPC, ↓C/Y/asset£/wealth/conf
–> ↓I = delay purchases, ↑payments, ↓bus conf
–> ↓G = dearer borrowing
–> ↓X =↑currency (↑M,↓X)
–> Pros = ↓inflation, discourage debt, ↑S, ↓asset £, ↓M (↓AD), future flexibility, sustainable lending
–> Cons = ↓growth/emp, ↓I, ↑CA deficit, -ve impact on indebted
10
Q
Transmission mechanism
A
- How interest feeds through the economy causing inflation
–> Market rate
–> House prices
–> Expectations
–> Exchange rates
11
Q
Quantitative easing/tightening
A
- QE
1) Add money BoE balance sheet
2) Buy gilts
3) Gilt price ↑
4) Yield ↓ (inverse relationship)
5) Interest rate ↓ (bank rate influences by yield
6) ↑AD
–> Pros = growth, ↓deflation, stabilise fin market, encourage I
–> Cons = inflation, asset bubble, ↑Y, ↓efficiency - QT
1) Stop buying gilts
2) Existing gilts mature
3) Hold principle + coupon in reserve
4) ↓money in economy
5) Interest rate ↑ (scarcity)
6) ↓AD
–> Pros = ↓inflation
–> Cons = ↓growth, ↓liquidity, ↑volatility
12
Q
Forward guidance
A
- BoE communicated future mon policy (bank rate, QE, etc.)
- Gradual guidance = ↓volatility
- Types
–> Time-based
–> State-dependant
–> Qualititative
–> Threshold-based
–> Open-ended - Pros = ↓uncertainty, ↑MP effect, support econ stability
- Cons = credibility concerns, ↓flexibility, unintended consequences
13
Q
Funding for lending
A
- Launched to boost lending after 2008
- Banks borrow cheaply, increases availability for borrowers
- TFS = borrow near bank rate for 4 years
- TFS with SME incentives
14
Q
Financial market failure
A
- Causes
–> Excessive loss (speculation, asset bubbles, asymmetric info)
–> Financial crisis/ recession
–> Bank bailouts - Collusion to fix interest/ exchange rates against consumer interests
–> Market rigging (fines) - Deregulation
–> No capital/liquidity ratios
–> No reserve requirements
–> Use commercial funds for risky investments
15
Q
Bank regulation
A
- Limit freedoms to ensure ethical behaviours
- Reasons
–> Asymmetric info
–> Moral hazard
–> Market bubbles
–> Market rigging
–> Systemic risk - How banks can fail
–> Lost confidence
–> LR lending (lack liquidity)
–> SR borrowing (credit crunch vulnerability)
–> Risk incentive in investment division of commercial banks - Systemic risks (other banks fail)
16
Q
UK financial regulators
A
- FPC (Financial Policy Committee) - BoE
–> Macroprudential
–> Remove risks
–> Instruct PRA/FCA
–> Advise govt
–> Raise awareness of systemic risk - PRA (Prudential Regulation Authority) - BoE
–> Microprudential
–> Set institute standards
–> Maintain stability
–> Supervise risk management - FCA (Financial Conduct Authority) - Treasury
–> Regulate fin sector
–> Protect C’s interests
–> Ensure UK fin integrity
–> Promote comp
–> Supervise conduct/fin products - Oth = liquidity/capital ratios
17
Q
Problems with financial regulators
A
- Moral hazard
- Regulatory capture
- Asym info (banks > reg)
- Info failure (loopholes)
- Unintended consequences (shadow banking, disincentivise commercial banking, bank failure)
- Admin/enforcement costs
