Macro Book 4

Question 1

4 functions of money

Answer 1

1. a medium of exchange
2. a store of value
3. a unit of account or measure of value
4. a standard of deferred payments (e.g. credit or long-term contracts)

Question 2

characteristics of money (6)

Answer 2

• difficult to forge
• limited in quantity
• portable
• durable
• divisible
• accetable to all

Question 3

narrow money

Answer 3

money that can be used as a meium of exchange; cash and liqiud deposits in banks/building societies

Question 4

broad money

Answer 4

includes everything in narrow money but also assets that serve as stores of value but are too illiquid to serve as a medium of exchange

Question 5

sight deposit

Answer 5

money deposited with a financial institution that can be withdrawn at any time with no penalty. e.g. accessing current account funds through an ATM

Question 6

time deposit

Answer 6

money deposited with a financial institution that can only be withdrawn after a certain notice period or from which withdrawals incur a penalty e.g. some savings accounts

Question 7

liquidity

Answer 7

the ease with which an asset can be converted into cash without loss of value

Question 8

financial markets

Answer 8

markets for financial assets

Question 9

money markets

Answer 9

• provide short-term lending/borrowing
• assets mature in less than a year
• include treasury bills and commercial bills
• promote liquidity

Question 10

capital markets

Answer 10

• trading in securities e.g shares and bonds
• medium to long term (1yr+)
• can fund long-term growth

either primary or secondary markets
- primary = new issues or bonds newly issued by the government
- secondary = securities resold second-hand

Question 11

foreign exchange markets

Answer 11

• trade in foreign currencies
• biggest financial markets (FX trades regularly exceed $6tn a day)

Question 12

bills

Answer 12

• short dated loans raised either by governments (treasury) or firms (commercial)
• no interest
• ‘sold at discount, redeemed at parity’ (sold for less than face value so buyer recieves more than they paid at maturity)

Question 13

bonds

Answer 13

• either corporate (firms) or a government bond (gilts)
• long-term borrowing
• guaranteed amount of annual interest (called a coupon)

Question 14

yield =

Answer 14

annual coupon
current market price x100

Question 15

3 main types of banks

Answer 15

• central
• commercial
• investment

Question 16

central bank

Answer 16

• acts as a national bank and provides services to the government and the banking system
• controls monetary policy
• e.g Bank of England, federal reserve, ECB

Question 17

commercial bank

Answer 17

aims to make a profit by selling banking services to customers

Question 18

investment bank

Answer 18

• doesn’t generally accept deposits from customers
• offer financial advise and consultancy with stock market flotations, M&A etc.

Question 19

commercial bank objectives (3)

Answer 19

• profitability
• liquidity
• security

Question 20

fractional reserve banking

Answer 20

a system of banking where only a fraction of deposits are held in cash available for withdrawal (the rest is advanced to borrowers)

Question 21

reserve requirement

Answer 21

the proportion of deposits that a commercial bank is required to retain in a system of fractional reserve banking

Question 22

money multiplier =

Answer 22

1
reserve requirement

(express reserve requirement as a decimal)

Question 23

functions of a central bank (7)

Answer 23

• help the government maintain macroeconomic stability
• bring financial stability
• act as a lender of last resort
• controlls note issue
• acting as the bankers bank
• acting as the goverments bank
• international obligations

Question 24

EVAL points on interest rate policies

Answer 24

1. time lags - BoE estimates a change in bank rate will affect output in a year but the full impact on inflation takes 2 years
2. size of the effect - 1 percentage point change in interest rates affects output by 0.2% - 0.35% after a year but affects inflation by 0.2 - 0.4pp after 2 years

Question 25

factors influencing base rate decisions (8)

Answer 25

- bank lending and consumer credit figures - asset prices - business confidence - consumer confidence - trends in FX markets - labour markets - international data - GDP growth and spare capacity

Question 26

how central banks influence the growth of the money supply

Answer 26

- volume of money produced - QE - interest rates - set reserve requirement - open market operations

Question 27

quantity theory of money

Answer 27

- irving fisher's equation of exhange: MV ≡ PQ M = money supply V = velocity of circulation P = price level Q = quantity of goods + services sold (short-run V and Q constant)

Question 28

macroprudential regualtion

Answer 28

concerned with identifying and monitoring risks to the overall stability of the financial system

Question 29

microprudential regulation

Answer 29

focus on ensuring the stability of individual banks and financial institutions

Question 30

FPC

Answer 30

- financial policy committee - part of the Bank of England - macroprudential regulator - main priority is stability of financial system overall

Question 31

PRA

Answer 31

- prudential regulation authority - part of the Bank of England - microprudential regulator - regulates and supervises individual banks, building societies, credit unions, insurers and major investment firms - responsible for stress testing UK banks

Question 32

stress test

Answer 32

looks at individual banks' resilience to various adverse scenarios e.g recession and rising unemployment

Question 33

FCA

Answer 33

- financial conduct authority - not part of the Bank of England - microprudential regulator - aims to make sure financial markets work well by promoting fair competition

Question 34

policies for greater financial regulation and counter arguements (3)

Answer 34

1. increase reserve requirement - bank keeps more of its deposits and lends less. Therefore they're more liquid, reducing risk of bank run. HOWEVER - reduces money multiplier, reducing AD 2. increase capital requirement - banks must fund more of their activity with their own funds. Less vulnerable to withdrawals and will take les risks HOWEVER - may limit their activity possibly reducing AD 3. stronger rules preventing regulatory capture - e.g. bank regulators forbidden from returning to the private sector for 5 years after leaving a regulator HOWEVER - reduces talent pool and regulators may have to pay more as there is lower incentive to work for them

Question 35

argument against regulation in the banking sector

Answer 35

increased regulation may decrease the UK's international competitiveness in an industry where it has a compartive advantage

Question 36

moral hazard

Answer 36

when a firm or individual, in pursuing profit, takes on too much risk whilst knowing someone else will bear a significant portion of the cost

Question 37

systemic risk

Answer 37

a risk posed to the whole financial system because of the connections between institutions and markets

Question 38

why banks fail (7)

Answer 38

- low capital ratio - low liquidity ratio - bank runs - actions of regulators - rogue employees - recklessness - governments let them (to set an example)

Question 39

capital ratio

Answer 39

the proportion of a bank's funding that has come in the form of equity (e.g. retained profit), as opposed to deposits etc.

Question 40

liquidity ratio

Answer 40

the ratio between a bank's liquid assets and its expected outflows