Paper 2 - Spec Savers! Flashcards
(217 cards)
1
Q
How could we measure globalisation?
A
- Difference between GNP and GDP of a country.
- Remittances as a % of GDP.
- Number of multinational corporations (MNCs) in foreign countries.
- Level of protectionism (e.g. tariffs / quotas).
- Membership of free trade agreements (e.g. WTO) / trading blocs (e.g. NAFTA).
2
Q
3 causes of globalisation
A
- WTO membership and the rise of free trade
- Containerisation and technological advances enabling ECONOMIES OF SCALE to be achieved
- Deregulation of financial markets (including in former Warsaw Pact)
3
Q
Who tends to have SWFs?
A
Countries with budgetary surpluses, often exporters of commodities
4
Q
2 benefits of FDI for LEDCs
A
- Shift AD to the right by increasing investment. Positive multiplier, cyclical employment and tax revenues
- LRAS shift to the right, including by TECHNOLOGY transfers enabling LEDCs to capitalise on COMPARATIVE ADVANTAGE and economies of scale achieved by MEDCs
5
Q
Harrod-Domar model
A
Investment is key to development. Finance is key to investment. The globalisation process has favoured LEDCs because they now have more access to global financial markets
6
Q
Technology transfers description
A
LEDCs can benefit on COMPARATIVE ADVANTAGE and ECONOMIES OF SCALE achieved in developed countries by importing technology from them. Such imports reduce costs for agents in the LEDC
7
Q
How can the globalisation of export markets help LEDCs?
A
Exports are an injection into the circular flow of income and hence have a MULTIPLIER. We have somewhere to sell our exports to increase AD
8
Q
Eval on the brain drain?
A
Remittances globally are on the rise. This may offset the effect of the brain drain, even make it beneficial, because workers can send back their wages and not claim on the government’s services
9
Q
What kind of competition do LEDCs engage in for FDI? Eval?
A
Competing to lower costs the most to attract FDI
Worse conditions for workers. But is this better than primary industry?
10
Q
Opportunity cost of the sweat shop
A
The domestic industry that preceded it
11
Q
How do technology transfers work?
A
Firm carries out R&D. Other firms in their market emulate the R&D. Those firms carry out FDI and take the R&D to LEDCs
12
Q
When are firms most likely to benefit from economies of scale created by globalisation?
A
When they have high fixed costs
13
Q
In a question evaluating globalisation, how could we make a nice essay?
A
Evaluate based on impacts on LEDCs vs MEDCs
14
Q
Benefits of globalisation for MEDCs?
A
- Labour market impacts - WAGE INFLATION - use this phrase!
- Increased choice and competition from imports - higher consumer surplus
- Export-led growth
15
Q
3 problems of globalisation for MEDCs?
A
- Adverse labour market impacts
- Interdependence and vulnerability to shocks - CONTAGION
- Exchange rate volatility due to hot money flows
16
Q
What allows countries to specialise?
A
Free trade
17
Q
Explain comparative advantage
A
Comparative advantage occurs for a country when it can produce a certain amount of a good or service with a lower opportunity cost of this production, in terms of another good or service, than another country. Suppose that two countries can make both guns and butter. If the first country sacrifices 3 guns to increase butter production by 1 unit, and the second country sacrifices 1 gun to produce 3 units of butter, then, ceteris paribus, the first country has a comparative advantage in the production of guns and the second country a comparative advantage in the production of butter.
18
Q
When comparative advantage occurs, world output…
A
Rises. Surplus hence must rise
19
Q
Comparative advantage can usefully be visualised as…
A
What a country is least bad at, given all countries must produce something
20
Q
Absolute advantage
A
A country can produce the same amount of goods/services with fewer resources than another country
21
Q
How is free trade allocatively efficient?
A
Resources are used most efficiently and productively, with no resources wasted
22
Q
How can free trade increase standards of living?
A
Reduce prices, increase consumer surplus and increase disposable income
23
Q
Example of how free trade increases choice?
A
Exotic fruits in the UK
24
Q
What is the effect of free trade on inflation?
A
Can reduce COST-PUSH inflationary pressures by reducing the costs of production faced by firms
25
Benefits of international trade
1. Economies of scale and higher productive efficiency
2. Greater competition and more consumer surplus as a result
3. Improved allocative efficiency due to increased world output
26
2 features of a customs union?
1. CET
2. Use of common internal regulations so that there are no trade barriers between countries - for example, universal quality regulation
27
A single market builds on a customs union by...
Increasing internal factor mobility and limitations on state aid
28
Why is WTO power limited?
Cannot enforce free trade. Has not been able, for instance, to stop Trump's tariffs
29
What is the effect of protectionism on specialisation?
Likely to worsen it because free trade is unlikely
30
2 key problems with import quotas?
1. Volume, not value, restricted. So would likely lead to cost-push inflation
2. No tariff revenue for government
31
4 types of protectionism?
1. Exchange rate manipulation
2. Non-tariff barriers e.g. embargoes and quotas
3. State aid to domestic firms
4. Tariffs
32
The aim of a tariff or non-tariff trade barrier is always to...
Increase the price of an import and reduce its competitiveness with domestic goods as a result
33
4 arguments for protectionism
1. Dumping
2. Reduce externalities of free trade
3. Protect domestic industries and sunset industries
4. Insulate infant industries and allow them to develop economies of scale
34
How could AD be increased by protectionism?
Incomes of domestic workers, insulated from foreign competition, rises. There is likely also to be a multiplier effect as the MPM decreases.
35
Further benefits of protectionism?
1. Reduce current account deficit (ASSUMING NO RETALIATION)
2. Raise tax revenue (ESPECIALLY IMPORTANT FOR LEDCs)
3. Increase domestic employment
36
Can protectionism improve the trade deficit?
Yes, but only if other countries don't retaliate
37
How can protectionism lead to inflation?
1. Input costs for firms rises if they import them. So SRAS shifts left.
38
How could, to the contrary, protectionism actually worsen unemployment?
If costs of necessities increases, disposable income to spend on other industries falls. So AD falls and unemployment is liable to rise
39
How could protectionism create a recession?
Export demand falls
40
4 negatives of protectionism
1. Recessionary effects as exports fall and consumer incomes fall. Export demand also falls because export prices rise if input costs increase
2. Inflationary effects from a rise in import prices for domestic firms
3. The risk of retaliation offsets the benefits
4. X-inefficiency from dependence on tariffs
41
We could easily evaluate against tariffs. What would be a nice point to round out an essay on protectionism?
It would be better to use SUPPLY-SIDE POLICIES to fix the trade deficit and improve domestic employment. LONG-RUN GROWTH AND LRAS SHIFTING RIGHT
42
Terms of trade versus balance of trade
Terms of trade - how much a country can import for a given amount of exports.
Balance of trade - the differences between the values of exports and the values of imports
43
Improvement in terms of trade
The country can buy more imports for each unit of exports
44
The average price of a country's exports increases while import prices remain the same. The effect on the terms of trade is to...
Improves. Country can buy more imports for each unit of exports.
45
Terms of trade formula
(Index of export prices)/(Index of import prices) x 100
46
Purchasing power of exports in terms of imports indicates
The terms of trade
47
2 possible disadvantages of single market membership?
1. CET can inhibit trade
2. Free movement can suppress wages in the labour market
48
Suppose there are two countries considering trade. For one unit of input resources:
Country A can produce 100 barrels of candy or 10 loaves of bread.
Country B can produce 50 barrels of candy or 8 loaves of bread.
Who has the absolute advantage in both products? Who has the comparative advantage in bread?
Absolute - Country A
Comparative - Country B
49
Where do remittances go on the balance of payments?
Secondary income balance (IF THEY ARE UNILATERAL TRANSFERS BACK TO FAMILY ETC.)
50
Does the uk have a current account surplus in the balance of trade of services?
Yes - Q4 2024, 6.8% of GDP was in the CA BOTIS surplus
51
Where does income from previous FDI made by British citizens go?
Primary income balance
52
Where does tourism go on the BOP?
Services balance on the CA
53
Where do hot money flows go on the BOP?
Financial account
54
Capital account
1. Transactions of intangible assets which are NOT financial e.g. property rights
2. Capital transfers - UNILATERAL MOVEMENTS e.g. debt forgiveness
55
4 causes for a persistent CA deficit
1. Low productivity
2. High domestic inflation (RELATIVE)
3. Over-valued exchange rate
4. Non-price constraints like poor quality
56
3 reasons a CA deficit might not be bad?
1. Imports of capital goods etc. implies future gains
2. Current account deficit help current standard of living
3. Primary account deficits imply that FDI was profitable
57
When is the CA deficit concerning?
When it represents supply-side problems with the economy and a wider exposure to contagion
58
How do we finance a CA deficit? Eval?
Financial account surplus - selling financial assets, even government borrowing
PROBLEM! Contagion risk
59
CA deficit can indicate what effect on the labour market and eval?
Domestic unemployment
Not if workers are employed in more productive industries and imports are to fill the gap e.g. primary imports
60
What can a CA deficit signal about the economic growth?
Stagnation decline as M is a withdrawal
61
5 causes of a CA deficit
1. Low productivity
2. Relatively high inflation
3. Stuck exchange rate
4. Non-price factors
5. Supply-side constraints
62
POLICIES TO SOLVE A CURRENT ACCOUNT DEFICIT CAN BE BROADLY...
SPLIT INTON EXPENDITURE-SWITCHING AND EXPENDITURE-REDUCING
63
Expenditure-switching definition
Change relative prices of exports and imports
64
Expenditure-reducing definition
Deflating to reduce import demand, ceteris paribus
65
How can attracting FDI be a solution to the current account deficit?
1. Financial account balances out current account
2. Long-term supply-side improvements
66
A unique eval point on FDI?
Can lead to foreign ownership of strategic assets e.g. Scunthorpe steel works
67
3 main benefits of a freely floating XR?
1. Monetary policy independence
2. Fix current account deficit
3. Less need to hold reserves
68
3 main downsides of a freely floating XR?
1. Uncertainty for firms who trade and the need for hedging - business cost!
2. Speculation
3. Cost-push inflation from exchange rate devaluations
69
Effect of Interest Rates on Exchange Rate
Higher interest rate -> hot money demand for currency -> appreciation -> reduce export demand
70
MONETARY TRILEMMA
Impossible to have fixed XR, capital mobility and independent monetary policy
71
The main way exchange rates cause cost-push inflation
A fall in the XR causes import prices for raw materials to rise
72
Example of a rigidly fixed exchange rate?
Hong Kong Currency Board
73
The main advantage of a fixed XR?
Stability for firms and households
74
What would a globally fixed XR do to world trade, in theory?
Increase it, because firms have certainty about future costs and spending on hedging decreases
75
3 components of the UK financial regulatory system and eval?
1. Financial Policy Committee (FPC)
2. Prudential Regulation Authority (PRA)
3. Financial Conduct Authority (FCA)
All subservient to the Bank of England, apart from the Financial Conduct Authority, who work for the Treasury
76
FPC and PRA history?
Both were formed as a direct result of the Financial Crisis
77
3 facts about the FPC?
1. Macroprudential regulator
2. Monitor and insure against systemic risk
3. Perform stress tests
78
3 things the FPC can do?
1. Ask the PRA to introduce microprudential regulation for a given risk
2. Ask the FCA to review market conduct and competition between certain firms
3. Advise the government on regulation
79
Stress tests
As of 2017, 2 stress tests per year, which test the system's resilience to a worst-case scenario.
80
Liquidity Assurance Scheme
FPC can give banks access to emergency liquidity
81
3 PRA facts
1. Maintain stability of individual banks
2. DEFINE THE SPECIFIC CAPITAL RATIOS, LIQUIDITY RATIOS AND RESERVE REQUIREMENTS required to be held by British banks
3. Micro-prudential
82
Eval on regulatory capture in the financial market regulation?
Tripartite regulation makes it less likely
83
FCA reports to...
Treasury
84
3 FCA facts
1. Ensure that competition is upheld and that collusion does not occur
2. Ban misleading products e.g. PPI crisis
3. Micro-prudential regulation
85
How could the FCA clash with the PRA?
FCA - want more competition
PRA - want more regulation
Compatible?
86
2 FPC powers?
1. Powers of direction - can instruct the FCA and the PRA to take action
2. Power of recommendation - can recommend regulation to government
87
Counter-cyclical buffer rate
The FPC can change this to increase systemic resilience. This is a capital base that can be increased when a financial downturn is anticipated
88
3 examples of regulatory measures under the FPC's Powers of Direction?
1. Capital requirements
2. Leverage ratio
3. Loan-to-value and debt-to-income limits for mortgages
89
5 examples of regulation the financial regulators could impose?
1. Ban collusive arrangements such as the LIBOR fixing scandal
2. Use debt-to-income limits to ensure sub-prime borrowers don't become overleveraged
3. Set a price ceiling on interest rates, particularly on emergency loans - risk of government failure from over-borrowing
4. RING-FENCING
5. Liquidity assurances - UK's Liquidity Assurance Scheme
90
Main problem of financial regulation?
Moral hazard from strong regulation
91
Why is competition sometimes a regulatory objective of the financial regulators?
Interest rate fixing less likely
92
What is deposit insurance?
In the UK, up to 85k is insured in the case of a run on the banks
93
Ring-fencing rationale?
Protect innocent consumers from unknown activities of investment bank activities
94
Paramount financial regulation? Eval?
Setting limits on ability to loan. Reduce the chance of bank failure from liquidity crises and solvency crises
95
How has the government reduced the potential for government failure in the Liquidity Assurance scheme?
Tight regulation on the bailout to prevent recurrence
96
Basel Agreement
A regulatory framework from a meeting in Basel to prevent a recurrence of 2008. They are only recommendations. But they are law in the EU. We have kept Basel 3.1 since Brexit
97
Cash ratio formula
Cash assets/current liabilities
(current is important)
98
The cash ratio is usually a number...
Less than 1. The higher it is, the more secure the sector
99
Effect of a high cash ratio?
Banks more able to cover a liquidity crisis if short-term liabilities set in
100
Is a liquidity ratio a cash ratio?
No
101
Liquidity ratio
Current assets/current liabilities
102
Current assets
Cash, BoE reserves, Money at short and call and Short term investments
103
Current liabilities
Usually deposits and SR borrowing
104
Intention of the liquidity ratio?
Banks have enough highly liquid assets (not necessarily cash but nevertheless HIGHLY LIQUID) to cover current liabilities and resist a LIQUIDITY CRISIS
105
Liquidity ratio in the UK
Since Basel - set at 60% in 2015 and raise to 100% by 2019. Which was successfully done
And LCR (liquidity coverage ratio) - banks must have 100% LIQUID ASSET COVERAGE for liabilities which are current to within 30 days.
106
Reserve requirement
The proportion of deposits which must be held in the Bank's BoE reserve account. Give liquidity
107
Are there reserve requirements in the UK?
No, but there are in the USA. No Basel recommendation
108
Capital ratio
Capital/loans
109
Capital for a bank
Shareholder input + Retained profit
110
Capital ratios are typically a number...
Which are low and below 1
111
Purpose of capital ratio?
Prevent insolvency -> bank failure
112
Basel recommendation for capital ratio
8% minimum
113
Why can the capital ratio be low?
Because many loans are secure so it is unlikely that they will experience a significant insolvency crisis
114
Problem with capital ratio?
Often only applied to more risky loans:
1. Discouraged more contentious lending, reducing business investment
2. Did not adequately insure against "safe" loans which went bad
115
What regulatory measure overcomes the problem of the capital ratio?
Leverage ratio
116
Leverage ratio
Capital/(ALL loans and long-term investments)
Relates assets to capital
117
Leverage ratio typical values?
Low value between 0 and 1
118
Function of leverage ratio?
Protect against insolvency and hence bank failure
119
Basel recommendation on leverage ratio?
3%
120
The leverage ratio is better than the capital ratio because...
It includes "safe" assets as well as risky assets
121
4 problems of financial regulation?
1. Moral hazard - LAS for instance - externalise the risk onto third parties
2. Regulatory capture - particularly from REVOLVING DOOR because of expertise
3. Asymmetric information
4. Unintended consequences e.g. capital ratio could reduce lending to riskier investments like business investment
122
What is the key evaluation for financial regulation?
Profitability must be traded off with protection of consumers because credit not being available can reduce AD
123
Why does moral hazard exist?
Imperfect information. Firms cannot reasonably charge more for insurance when people engage in risky activities
124
Insurance policy deductibles have what effect on moral hazard?
Reduce it because insured party now incurs some costs
125
Main things tested in a stress test?
If there was a sharp devaluation of asset prices, for instance due to a global recession, would the bank remain solvent?
126
Capital ratio is too high. This would create...
Inefficiency because the bank cannot loan these assets as advances
127
4 market failures in the financial market?
1. Moral hazard
2. Rigging e.g. LIBOR and Tom Hayes of UBS. Went to jail for 14 years
3. Speculation
4. Asymmetric information e.g. 110% mortgages before 2008
128
Bank run
Current liquid assets cannot meet current liabilities. LIQUIDITY CRISIS
129
Solvency crisis
Current liabilities exceed current assets
130
2 types of bank failure
1. Liquidity crisis
2. Solvency crisis
131
Where does capital go on the balance sheet?
Liabilities side, but it isn't really a liability
132
3 types of liability
1. Deposits
2. Short-term borrowing
3. Long-term borrowing
133
7 types of asset? Of which, which are liquid assets?
LIQUID
1. Cash
2. Reserve accounts
3. Money at short and call notice
4. Short-term investments
ILLIQUID:
1. Long-term investments
2. Advances
3. Fixed assets
134
Why can a liquidity crisis at one bank affect the whole sector, simply?
Banks may have a liquid asset of INTER-BANK LENDING. They will demand this back at short and call and this will be a liability for another bank
135
How does insolvency work?
A loss in the value of assets e.g. loans going bad cannot be covered by capital
136
2 reasons for ripple effects of bank failure?
1. Liabilities at other banks
2. Assets held at other banks go bad
137
HOW CAN GOVERNMENTS REDUCE THE RISK OF A SOLVENCY/LIQUIDITY CRISIS
The ratios we discussed earlier. Cash, liquidity, leverage, capital, reserve, LCR.
138
Cash ratio forces a bank to...
Hold enough cash to meet short-term liabilities
139
The 5 ratios
1. Cash ratio - enough cash to cover current liabilities
2. Liquidity ratio - as above, but including other liquid assets e.g. money at short and call notice
3. Leverage ratio - the ratio of capital to advances and other assets the bank owns
4. Capital ratio - simplified above - the ratio of capital to advances
5. Reserve requirement - fraction of deposits held at the reserve account (basically a cash ratio)
140
How do banks maximise profit and the problem?
Borrow short-term and lending long-term
Solvency crisis risk
141
Eval on Basel 3.1?
The government has delayed the implementation to 2027, from 2025 originally - COULD THIS BE A PROBLEM!
142
An exchange rate depreciation has what effect on national income, ceteris paribus?
Net injection
BEWARE ML CONDITION - if it doesn't hold, this would not be true!
143
AD slopes downwards because...
1. Real incomes are inversely proportional to price level
2. Balance of trade may improve as price levels fall
3. A high level of inflation implies high interest rates - which can incentivise saving, reducing demand, and also have deleterious effects on the XR
144
Investment basic definition
Expenditure which increases the capital stock of a country
145
AD factors affecting (X-M)
1. XR
2. Quality competitiveness
3. Relative inflation
4. Real income in the UK and AD for exports created by macro conditions in other countries
146
Accelerator effect
1. Increase in real national income
2. Increase in AD for firm's output
3. Both animal spirits and expected future rate of return rise
4. Firms increase investment more than proportionately
5. Can create a multiplier
147
Multiplier-accelerator interaction
Work of Paul Samuelson:
1. Initial increase in investment (aggregate expenditure and AD rise)
2. This injection creates a positive multiplier effect which stimulates a further rise in investment
3. This cycle continues until the economy meets its resource constraint. At this point, inflation is more likely than output increasing
4. Nominal multipliers exceed real multipliers. Firms reduce investment, creating a negative multiplier, which further reduces investment
148
Most volatile component of AD?
Investment, unless (X-M) and XR volatility is counted
149
2 TYPES OF GOVERNMENT SPENDING
1. Current spending i.e. transfer payments
2. Capital spending i.e. investments
150
Why does AD shift back right again when SRAS shifts left, making inflation worse? How can this be illustrated?
Workers bargain for higher wages, causing consumption and income to rise again, but with reflationary consequences
SRAS left and AD back to the right
151
What differentiates SRAS and LRAS
Whether factors of production are fixed or variable
152
Factor mobility and LRAS
More mobile factors will enable LRAS to shift right
153
The LRAS is vertical because it is assumed that...
1. The economy always returns to full employment in the long-run
2. It is impossible to output above LRAS without incurring inflation which would return us to LRAS
154
Problem with absolute advantage?
Does not contain the implicit cost (opportunity cost) - only shows differences in productivity
155
How would you illustrate a comparative advantage?
Draw two PPFs. Linear. The country with the shallower PPF, even if both points are below the other country, has a comparative advantage in the production of whatever good is on the x-axis
156
3 benefits of specialisation based on comparative advantage
1. Allocative efficiency - highest productivity
2. Lowest prices
3. Maximum global output - Pareto efficiency
157
2 sources of comparative advantage
1. Quantity of factors of production
2. Quality of factors of production
158
Is comparative advantage natural?
Not always. We can incubate one using training etc.
159
RPI includes...
Housing costs!
160
Eval on whether rise in average taxes will create cost-push inflation?
Are firms able to shift incidence to consumers? Therefore, is PED elastic?
161
Main inflationary impact of exchange rate depreciation?
1. Felt on the supply-side - cost-push SRAS inflation
2. Demand-side - demand for exports increases, whilst more expensive imports causes consumers to substitute for domestically produced goods
162
How can we import inflation? Two ways.
1. Excessive export demand
2. Global supply-side shock increasing cost of imports
163
Velocity of circulation
The number of times money is spent in the economy in a given period of time
164
Q in the Fisher Equation is...
Real GDP
165
Does anyone question the legitimacy of the Fisher Equation?
No. So long as withdrawals = injections, MV (national expenditure) must equal PQ (national output measured in nominal GDP terms)
166
How can we link the concept of the liquidity trap to the Keynesian interpretation of the Fisher Equation of Exchange?
During periods of negative output gaps and deficient AD, liquidity traps can occur due to low confidence and due to high real interest rates as a result of deflation. This causes V to fall. Hence, if the government increases M during a recession, they are less likely to be able to influence PQ. And even if they were, Q will rise as national income rises
167
How to show the effect of spare capacity on multiplier?
Use a Keynesian LRAS
168
Eval on measuring output gaps?
Hard to measure
169
When discussing exchange rate changes, diagrams to use are...
AD/AS WITH EXCHANGE RATE DIAGRAMS IN PARALLEL
170
It is noted that, when drawing a J-curve, it is usually best...
Not to take the curve into trade surplus territory because it is unlikely to do this. Supply-side policies would be necessary to improve the underlying trade deficit
171
Kuznets curve
Could be used to illustrate development and inequality
172
What effect does an increase in QE have on bond prices?
Drives them up, and yield falls
173
What goes on the x-axis of a Kuznets curve?
GNI per capita (PPP)
174
How do you show stagflation on a SRPC?
Shifting it to the right
175
NAIRU vs NRU
NAIRU is at LRPC, as is NRU, but NAIRU uses Friedman terminology
176
The cause of the deflationary spiral is...
The fact that the real interest rate exceeds the nominal interest rate because of deflation
177
What key labour market effect can inflation have?
Help to "unstick" wages
178
The redistributive effect of fiscal policy is considered...
Whereas the effect on funding public and merit goods is considered...
Macroeconomic
Microeconomic
179
Whenever you address changes to real incomes, it would be prudent to emphasise...
Whether disposable, discretionary or total incomes are being affected
180
Income tax in the UK - basic facts
1. 12,570 for 20% threshold
2. By 125,140 and above it is 45%
MARGINAL always - so on the additional units of income above the previous threshold
181
How does a regressive tax work?
Same amount for each consumer, meaning that at higher incomes it is a smaller proportion of income
182
What does the canon of equality actually mean?
Affects taxpayers equally. Does this mean the value is equal, or does it mean that the average tax burden is equal? Should the rich therefore pay more or less?
183
What evidence is there that real-life MPCs are high?
Japelli (1990) - 20% of American public is credit-constrained
Gross & Souleles (2002) - 2/3 of people respond to increases in credit card overdraft limits by spending more
184
Key evaluation with national debt
Debt as a proportion of GDP is what matters! Nominal debt figures are not significant
185
4 key arguments in determining whether the national debt/budget deficit is significant
1. There is an inverse relationship between bond quantity and price due to bond market dynamics (DRAW A DIAGRAM!). So more borrowing can increase bond yields and the cost of borrowing, especially if investors lose confidence in the borrowing
2. The opportunity cost of this tax spending
3. REAL GDP:DEBT IS WHAT MATTERS. If the spending is improving capital stock and hence LRAS, then an increase in tax revenues may offset
4. KEYNESIAN CROWDING IN EFFECT - opposite of crowding out - promotes private sector investment
186
Structural deficit
The part of the budget deficit that persists when the government is at full employment
187
Crowding in
The opposite of crowding out - lead to increased private sector investment because AD has been increased by government's expansionary fiscal/monetary policy
188
3 cons of budget deficit/debts?
1. Lower confidence -> lower credit ratings. MOODY'S REDUCED US RATING IN MAY 2025. This means that governments must increase coupon rates to regain their bond demand. ALSO REDUCE FDI!
2. POLICY CONFLICT with inflation
3. CROWDING OUT
189
3 evaluations of deficits/debts
1. Pre-existing state of government finances is important - if you already have a substantial deficit/debt, then confidence is more likely to be undermined
2. State of economy significant - a negative output gap and unemployment may be less preferable than the cons of national debt
3. Long-run benefits could outweigh the short-run borrowing if LRAS increases
190
Credit rating for the US?
May - Moody's got rid of the last triple A rating
191
Financial crowding out fundamentally...
Works by raising interest rates paid by the private sector on loanable funds
192
Who could we bring in when discussing whether the UK's public finances are sustainable?
The OBR, set up in 2010 by the Coalition government
193
Key functions of the OBR
1. Biannual medium-term forecast
2. OBR rules on whether the government's economic policy has a greater than 50% chance of meeting the Treasury's fiscal targets
3. Give an independent group access to important data and reduce impact of COUNTER-CYCLICAL BIAS
194
Supply-side improvement vs supply-side policy - approved definition
Supply-side improvement is PRIVATE sector, supply-side policy is PUBLIC sector or government policy driven
195
Evidence eval of Laffer Curve?
Most Western countries are below efficient tax rate, according to recent evidence. MORE LIKELY TO BE OVERTAXING IN MEDCs DUE TO EFFECTIVENESS OF TAX POLICY, THOUGH.
196
Expansionary fiscal contractionism is linked to what phenomenon?
Crowding out
197
Equity vs debt
Two alternative approaches towards raising business finance. Debt involves taking on a liability. Equity involves selling a share in the company
198
Benefit of debt vs equity for business finance?
Untaxed in some cases
199
What can a commercial bank use to absorb current liabilities and avoid a liquidity crisis?
CURRENT ASSETS
1. Cash
2. Reserve accounts
3. Money at short-and-call notice
4. Short-term investments
Short-and-call - could be dependent on other failing banks
200
3 aims of commercial banks and trade-offs?
1. Liquidity - need to keep enough liquid assets to avoid liquidity crises. But the LIQUIDITY/PROFITABILITY TRADE-OFF is significant
2. Profitability - inverse of the above
3. Security - must act to ensure its assets are safe e.g. insuring with collateral or checking asset quality
201
For a bank's balance sheet...
Assets must always equal liabilities
202
Key term to use when describing the cause of bank failure?
Lending long-term
Borrowing short-term
203
The Hong Kong Currency Board sets XR with reference to...
The USD, an example of a fixed exchange rate with a trade partner. Setting a fixed exchange rate with a key trading partner is advantageous.
204
2 benefits of a fixed XR?
1. Government forced to employ non-inflationary fiscal and monetary policy because DP inflation cannot simply be corrected by the floating XR
2. Stability can encourage trade and FDI
205
When is the monetary policy trade-off with interest rates not a problem?
When the state of the economic cycle and the current account deficit are not "out of phase".
206
Speculative attack
Buying and selling by FOREX traders to try and undermine a fixed exchange rate peg
207
Why are fixed exchange rates expensive for central banks?
Large opportunity costs in holding currency reserves
208
3 problems with currency union?
1. Substantial trade deficits could develop within the single currency for the same reasons as they could develop in a fixed XR. The Greek debt crisis is an example. Greece was essentially selling debt into international markets to balance the BOP.
2. Loss of monetary policy independence prevents inflation/reflation control
3. Could substantially affect trade between members within the currency union and those outside, because weak exporters cannot depreciate/devalue their currencies to maintain international competitiveness
209
3 advantages of currency union?
1. Increase certainty for firms and hence encourage trade - reduced spending on hedging
2. Increasingly stable internal trade can foster investment and business confidence in member countries, potentially leading to supply-side improvements and LRAS shifting right
3. Fiscal policy must be prudent
210
4 reasons for changes in the pattern of trade?
1. Changes in relative exchange rates (NOTE THAT FREELY FLOATING XRS CAN DIFFER BETWEEN CURRENCIES)
2. Growth of trade blocs, but also external trade barriers created by trade blocs
3. Changes in patterns of comparative advantage e.g. reduced labour costs in LEDCs and deindustrialisation
211
Example of how a devaluation can affect trade?
Brazil - 2015 had a 30% devaluation due to a political emergency. Increased affordability prompted people to visit Brazil in greater numbers
212
Terms of trade
The price of a nation's exports relative to the price of a nation's imports
213
TERMS OF TRADE FORMULA
(Average export price index / Average import price index) x 100
214
A nation can buy more imports given the same volume of exports. The terms of trade...
Have improved
215
Explain the impact on the terms of trade from a rise in oil prices for a heavily oil-export dependent economy like Brazil.
Improve terms of trade ceteris
216
4 factors determining terms of trade
1. Technological advance
2. Tariffs (AUTOMATICALLY WORSEN)
3. Price booms in certain markets (e.g. commodity price boom and exporter of commodities)
4. Exchange rate
217
Following a worsening of the terms of trade, any country who continues to trade the same value of goods and services...
Necessarily experiences a change in the current account balance
