Financial Markets and Money Supply
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Questions and Answers

What distinguishes money markets from capital markets?

Money markets provide short-term finance, while capital markets offer medium and long-term finance.

How can government policies influence the demand for credit?

Government policies can either incentivize or deter borrowing, directly affecting the demand for credit.

Explain the role of fractional reserve banking in credit creation.

Fractional reserve banking allows banks to hold a fraction of deposits as reserves while lending out the rest, effectively creating credit.

What is the money multiplier, and how is it calculated?

<p>The money multiplier is calculated as $1 / ext{Reserve Ratio}$ and indicates how much money supply can increase with each dollar of reserves.</p> Signup and view all the answers

Identify two factors that can limit a bank's ability to create credit.

<p>Reserve ratios and the availability of suitable borrowers can limit a bank's ability to create credit.</p> Signup and view all the answers

What are the differences between nominal and real interest rates?

<p>Nominal interest rates are the stated rates before inflation adjustment, while real interest rates are nominal rates minus the inflation rate.</p> Signup and view all the answers

How does inflation affect the supply of credit?

<p>Inflation can lead to increased demand for credit as consumers and businesses seek to borrow at fixed rates before costs rise further.</p> Signup and view all the answers

What impact do poor lending practices have on the credit market?

<p>Poor lending practices can lead to banks extending loans to uncreditworthy borrowers, increasing the risk of defaults.</p> Signup and view all the answers

What is the formula for calculating the real interest rate?

<p>Real Interest Rate = Nominal Interest Rate − Inflation Rate</p> Signup and view all the answers

How do increased interest rates affect disposable income for homeowners in Ireland?

<p>Higher interest rates lead to increased mortgage costs, reducing disposable income for homeowners.</p> Signup and view all the answers

In what way can rising interest rates increase the risk of personal bankruptcies?

<p>Rising interest rates can cause borrowers to struggle with repayments, leading to loan defaults and personal bankruptcies.</p> Signup and view all the answers

What is one effect of a decrease in interest rates on consumer savings behavior?

<p>Lower interest rates discourage saving as returns diminish, encouraging consumers to spend more.</p> Signup and view all the answers

How do financial markets facilitate the movement of money?

<p>Financial markets allow for the movement of money across time and geography by offering interest rates to balance risk.</p> Signup and view all the answers

What role do financial institutions have in providing credit?

<p>Financial institutions provide credit facilities, pool risk, and offer investment advice.</p> Signup and view all the answers

What is a potential disadvantage of less competition in the banking sector?

<p>Less competition can lead to higher prices and fewer choices for consumers, decreasing their standard of living.</p> Signup and view all the answers

How does the Central Bank of Ireland regulate the banking sector?

<p>The Central Bank ensures stability of the financial system and protects customer financial services.</p> Signup and view all the answers

What was one outcome of the Tracker Mortgage controversy in Ireland?

<p>The Central Bank compelled lenders to compensate affected customers and enforced accountability measures.</p> Signup and view all the answers

What is one argument for regulation in the banking sector?

<p>Regulation ensures consumers are charged a fair price for banking services.</p> Signup and view all the answers

How does an increase in the savings rate affect the banks?

<p>An increase in the savings rate enhances liquidity and stability in the banking sector.</p> Signup and view all the answers

What is one economic advantage of non-cash-based payment methods for consumers?

<p>Non-cash-based methods offer increased convenience and create a digital record that is easy to trace.</p> Signup and view all the answers

In what way do lower interest rates encourage economic growth?

<p>Lower interest rates make borrowing cheaper, which increases consumer spending and encourages investment.</p> Signup and view all the answers

How do higher interest rates typically impact business investment?

<p>Higher interest rates discourage businesses from investing due to increased borrowing costs.</p> Signup and view all the answers

Study Notes

Financial Markets

  • Money markets facilitate short-term finance for industries, companies, banks, governments, and more, typically used for day-to-day operations.
  • Capital markets provide medium and long-term finance to governments (bonds) and firms (shares), allowing them to raise funds for long-term goals.
  • Foreign exchange markets are where different currencies are bought and sold.

Money Supply

  • Demand for Credit:
    • Interest rates are the cost of borrowing money.
    • Future expectations of the international economic climate influence firms' investment decisions.
    • Government policies can encourage or discourage borrowing.
  • Supply of Credit:
    • Excess credit supply can cause demand-pull inflation.
    • Increased credit availability can lead to higher imports due to increased purchasing power.
    • Poor lending practices by banks can extend credit to uncreditworthy borrowers, posing risks.

How Banks Create Credit

  • Banks operate under a fractional reserve banking system, holding reserves less than the total amount of claims outstanding.
  • Banks can create credit through this system.
  • The money multiplier is calculated by dividing 1 by the reserve ratio.

Limitations of Bank Credit Creation

  • Reserve Ratios: Banks are legally required to hold a certain percentage of cash as reserves against deposits.
  • Lack of Cash Deposits: Banks need depositors to provide funds for lending and must offer competitive interest rates to attract them.
  • Availability of Suitable Borrowers: When banks run out of suitable borrowers, they might extend credit to less creditworthy individuals, increasing risk.

Interest Rates

  • Interest is a percentage payment for borrowing or earning on deposits.
  • Nominal Interest Rate: The rate before adjusting for inflation.
  • Real Interest Rate: Nominal interest rate minus inflation rate.

Effects of Interest Rate Changes on the Irish Economy

Increased Interest Rates

  • Mortgage Repayments: Higher interest rates raise mortgage costs, reducing disposable income for homeowners with tracker or variable-rate mortgages.
  • Economic Growth: Increased borrowing costs deter consumer spending, which can slow economic growth.
  • Loan Defaults: Higher interest rates can make it difficult for some borrowers to repay loans, leading to defaults and potential bankruptcies.
  • Investment: Businesses may be less likely to invest in capital goods and expansion due to higher borrowing costs.
  • Consumption: Higher interest rates can encourage savings, leading to reduced spending and lower aggregate demand.
  • Unemployment: Decreased consumer spending and investment can reduce demand for labor, potentially increasing unemployment.

Decreased Interest Rates

  • Borrowing: Lower interest rates make borrowing more affordable, increasing spending power and potentially improving living standards.
  • Investment: Reduced borrowing costs and higher marginal efficiency of capital can encourage businesses to invest.
  • DIRT Revenue: Lower savings rates can reduce government revenue from Deposit Interest Retention Tax (DIRT).
  • Savings: Lower returns on savings make saving less attractive, potentially leading to increased consumer spending.
  • Mortgage Repayments: Lower interest rates decrease mortgage repayments, boosting disposable income and living standards.
  • National Debt Servicing: Lower interest rates reduce the cost of repaying the internal portion of the national debt.
  • Economic Growth: Increased investment and consumer spending can stimulate economic growth.
  • Employment: Higher consumer spending and investment can increase demand for labor, potentially leading to increased employment.

Financial Markets

  • Finance markets facilitate the movement of money across time and geography through interest rates, balancing risk between borrowers and lenders.
  • They enable global financial transactions by allowing the flow of money across borders.

Financial Institutions in Ireland

  • Stock brokers: Facilitate buying and selling of stocks.
  • Commercial banks: Provide various financial services, including lending, deposits, and payment processing.
  • Credit unions: Cooperatively owned financial institutions primarily serving members.
  • Insurance firms: Provide insurance products to protect individuals and businesses against risks.
  • Investment funds: Pool money from multiple investors to invest in diverse assets.

Role of Financial Institutions

  • Provision of Credit Facilities: Lenders provide financing to individuals and businesses.
  • Risk Pooling: Institutions spread risk across multiple individuals or investments, mitigating individual exposure.
  • Investment Advice: Financial advisors provide guidance on investment strategies.

Effects of Less Competition in Banking

  • Standard of Living: Decreased competition can lead to higher prices and fewer choices, potentially lowering living standards for consumers.
  • Rural Economic Activity: Limited banking competition may restrict access to financial services in rural areas, impacting local economic activity.
  • Consumer Banking: Reduced competition can mean fewer options for consumers, potentially leading to job losses in the banking sector.

Banking Regulation

Role of the Regulator (Central Bank of Ireland)

  • Prevents unauthorized financial providers from operating.
  • Enforces stricter regulation on banks than other financial institutions to protect depositors and control the money supply.
  • Aims to ensure the stability of the financial system and protect customer financial services.

Arguments for Banking Regulation

  • Fair prices for consumers.
  • High-quality financial services.
  • Higher equity requirements to improve financial stability.
  • Lower risk of financial crises.
  • Reduced costs for taxpayers due to less need for bailouts.

Arguments Against Banking Regulation

  • Makes it more difficult for Irish businesses to access finance.
  • No guarantee that regulation will always be effective.
  • Can lead to high levels of administrative work.
  • High barriers to entry can hinder new financial companies from entering the market.

Effectiveness of Regulation

  • Financial System Stability: The Central Bank updates its crisis management protocols and has a coordinated plan to respond to potential threats to the financial system.
  • Consumer Financial Service Protection: Following the Tracker Mortgage controversy, the Central Bank required lenders to compensate affected customers and implemented accountability measures.

International Regulators: IMF and World Bank

  • Assess countries' financial markets and provide policy recommendations to prevent future crises.
  • The IMF played a crucial role in Ireland's 2010 bailout package.

Central Bank of Ireland

  • Gabriel Makhlouf, the Governor of the Central Bank of Ireland, is a member of the European Central Bank's (ECB) Governing Council.
  • The Central Bank plays a significant role in the Irish economy.

Key Roles of the Central Bank

  • Price Stability: Managing inflation.
  • Regulation: Overseeing the financial sector.
  • Protection of Consumers of Financial Services: Advocating for consumer rights in financial transactions.
  • Banker to the Government: Managing government finances.
  • Efficient Payment Systems: Facilitating smooth and effective payment transactions.
  • Independent Economic Advice: Providing impartial economic analysis and data.
  • Recovery and Resolution of Financial Institutions: Managing distressed financial institutions.

Impact of Increased Savings Rate on the Irish Economy

  • Liquidity and Stability: Higher savings can improve liquidity and stability in the banking sector.
  • Aggregate Demand: Increased savings may lead to a decline in aggregate demand and delayed consumption.
  • DIRT Revenue: Higher savings rates can increase government revenue from Deposit Interest Retention Tax (DIRT).

Economic Advantages of Non-Cash Payment Methods

Advantages for Consumers

  • Convenience: Easier and more convenient to make payments.
  • Digital Record: Transactions are digitally recorded and easy to track.
  • Reduced Risk of Theft: Less risk of losing cash during transactions.

Advantages for Banks

  • Time Savings: Reduced time spent processing cash transactions for staff.
  • New Banking Methods: Opportunities to develop and implement improved banking services.
  • Staff Reduction: Potential for cost savings through reduced staffing needs.
  • Reduced Risk of Robbery: Lower risk of cash-related robberies.
  • Lower Insurance Premiums: Lower insurance premiums with reduced cash handling.

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Description

This quiz covers key concepts in financial markets, including the roles of money markets, capital markets, and foreign exchange markets. It also explores the demand and supply of credit, how banks create credit, and the implications of credit availability on the economy. Test your understanding of these fundamental topics in finance.

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