The Economic Environment chp 2
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What type of economies will be discussed in relation to factors determining economic activity?

  • State-controlled and market economies (correct)
  • Mixed and open economies
  • Planned and free market economies
  • Command and traditional economies

    • In the context of economic development, what are two categories of factors affecting economic growth?

  • Geographic and political factors
  • Demand-side and supply-side factors (correct)
  • Social and cultural factors
  • Technological and environmental factors

    • Which types of economies are considered as 'state-controlled' in the text?

  • Traditional and socialist economies
  • Command and planned economies (correct)
  • Open and free market economies
  • Market and mixed economies

    • What is the primary focus when splitting factors affecting economic growth according to the text?

    <p>Demand-side and supply-side factors</p> Signup and view all the answers

    Which factor is NOT mentioned in the text as influencing economic development?

    <p>Foreign exchange rates</p> Signup and view all the answers

    What is the main purpose of analyzing economic measures in the chapter?

    <p>To assess the economic conditions of a country</p> Signup and view all the answers

    In a state-controlled economy, what primarily replaces profit as the incentive for production?

    <p>Common good</p> Signup and view all the answers

    What main characteristic distinguishes a market economy from a state-controlled economy?

    <p>Forces of supply and demand</p> Signup and view all the answers

    Which economic system is characterized by a combination of market economy and some state control?

    <p>Mixed economy</p> Signup and view all the answers

    What can be the result in a market economy if there is oversupply in a certain product?

    <p>Producers leaving the market</p> Signup and view all the answers

    Why might planned economies introduce reform towards a more mixed economy according to the text?

    <p>To address large inequalities</p> Signup and view all the answers

    What is the primary factor that determines resource allocation in a market economy?

    <p>Consumer demand</p> Signup and view all the answers

    Which aspect of the economy is influenced by competition in a market economy?

    <p>Wage levels</p> Signup and view all the answers

    What is the main drawback associated with state-controlled economies in terms of individual choice?

    <p>'Common good' focus</p> Signup and view all the answers

    Why do mixed economies combine elements of both market and state-controlled systems according to the text?

    <p>'Welfare support' provision</p> Signup and view all the answers

    Which country was the best-known example of a state-controlled economy throughout most of the 20th century?

    <p>Soviet Union</p> Signup and view all the answers

    What is the main way through which governments raise finance for public expenditure?

    <p>A combination of collecting taxes and borrowing in the capital markets</p> Signup and view all the answers

    What does the term 'protectionism' refer to?

    <p>Creating barriers to protect domestic markets</p> Signup and view all the answers

    Which organization exists to promote the growth of free trade between economies?

    <p>World Trade Organization (WTO)</p> Signup and view all the answers

    What is the main objective of macroeconomic policy?

    <p>Ensuring full employment</p> Signup and view all the answers

    During which stage of the economic cycle is GDP at its highest point?

    <p>Peak</p> Signup and view all the answers

    What categorizes under stabilisation policies in managing economic fluctuations?

    <p>Both fiscal and monetary policies</p> Signup and view all the answers

    What characterizes the expansion phase of the economic cycle?

    <p>'Trough' marks the end of economic contraction</p> Signup and view all the answers

    What happens during the contraction phase of the economic cycle?

    <p>'Recession' is expected with two consecutive quarters of declining GDP</p> Signup and view all the answers

    Which stage signifies that the contraction phase is over in the economic cycle?

    <p>'Trough'</p> Signup and view all the answers

    'Protectionism' generally aims to:

    <p>Preserve domestic markets by restricting imports</p> Signup and view all the answers

    What is the primary goal of fiscal policy?

    <p>Influencing the condition of the economy</p> Signup and view all the answers

    How does increased government spending affect the economy according to fiscal policy?

    <p>Stimulates economic activity</p> Signup and view all the answers

    What happens to the balance of payments when economic growth improves?

    <p>It deteriorates</p> Signup and view all the answers

    How does a budget surplus affect the government's actions?

    <p>Provides room for tax cuts</p> Signup and view all the answers

    What is one implication of fiscal policy for businesses in terms of total labor costs?

    <p>Increase in labor costs</p> Signup and view all the answers

    Which tool is used by governments under monetary policy to control inflation by restricting credit lending?

    <p>'Credit squeeze'</p> Signup and view all the answers

    What is the relationship between the interest rate and the level of spending in the economy according to monetary policy?

    <p>Inverse relationship</p> Signup and view all the answers

    How do governments target the stock of money in the economy under monetary policy?

    <p>'Quantitative easing'</p> Signup and view all the answers

    'Contractionary' fiscal policy emphasizes which of the following?

    <p>Reducing government spending and/or raising taxes</p> Signup and view all the answers

    'Expansionary' monetary policy is aimed at achieving which of the following?

    <p>'Quantitative easing' and increasing money supply</p> Signup and view all the answers

    What is the primary purpose of increasing interest rates in an economy?

    <p>To discourage borrowing and spending</p> Signup and view all the answers

    How can higher interest rates affect corporate investments?

    <p>Decline due to higher borrowing costs</p> Signup and view all the answers

    What is a potential consequence of higher interest rates on mortgage payments?

    <p>Rise in mortgage defaults</p> Signup and view all the answers

    What is the role of central banks as lenders of last resort?

    <p>To lend money to commercial banks during financial crises</p> Signup and view all the answers

    How do higher interest rates affect the balance of payments?

    <p>Contribute to the deficit by appreciating the exchange rate</p> Signup and view all the answers

    What is the main function of the Bank for International Settlements (BIS)?

    <p>Assist central banks in pursuing monetary and financial stability</p> Signup and view all the answers

    In an open economy, why is it difficult for individual governments to control economic policy?

    <p>Because financial markets play a significant role in policy making</p> Signup and view all the answers

    What is the significance of central banks operating independently from government control?

    <p>To ensure stability and prevent political influence on monetary decisions</p> Signup and view all the answers

    How do central banks influence the value of a nation's currency?

    <p>By controlling the money supply</p> Signup and view all the answers

    What is one of the key responsibilities of central banks regarding bank deposits?

    <p>Safeguarding depositors' funds</p> Signup and view all the answers

    Which central bank is responsible for setting monetary policy for the entire eurozone?

    <p>European Central Bank (ECB)</p> Signup and view all the answers

    What is the primary focus of the Monetary Policy Committee (MPC) of the Bank of England?

    <p>Ensuring inflation is kept within a government-set range</p> Signup and view all the answers

    Which central bank was founded in 1694 but gained operational independence in 1997?

    <p>Bank of England</p> Signup and view all the answers

    What does the Federal Open Market Committee (FOMC) primarily focus on?

    <p>Ensuring price stability and sustainable economic growth in the US</p> Signup and view all the answers

    Which central bank provided liquidity to US banks during the financial crisis?

    <p>Federal Reserve</p> Signup and view all the answers

    What does the European Central Bank (ECB) aim to keep inflation close to, as per the text?

    <p>$2% in the medium term</p> Signup and view all the answers

    Which central bank is responsible for managing the external value of the Japanese yen?

    <p>Bank of Japan</p> Signup and view all the answers

    What is the primary policy instrument used by the Monetary Policy Committee (MPC) of the Bank of England?

    <p>$GBP exchange rate</p> Signup and view all the answers

    The Single Supervisory Mechanism (SSM) of which central bank aims to ensure banking supervision in eurozone states?

    <p>$ECB</p> Signup and view all the answers

    'Price stability and sustainable economic growth' are core responsibilities of which central bank committee?

    <p>$FOMC of Federal Reserve</p> Signup and view all the answers

    What is the primary reason why governments aim to control inflation at a level of about 2–3% per annum?

    <p>To maintain the real value of salaries and incomes</p> Signup and view all the answers

    In the context of inflation, why might high levels of inflation cause problems for businesses?

    <p>Prices need constant updating</p> Signup and view all the answers

    What impact does high inflation have on individuals on fixed levels of income, such as pensioners?

    <p>The value of their income is eroded</p> Signup and view all the answers

    How does high inflation affect the competitiveness of a country's exports?

    <p>Exports become less competitive</p> Signup and view all the answers

    Why might high inflation act as a disincentive for people to save money?

    <p>As it reduces the value of future pensions and savings</p> Signup and view all the answers

    What impact does high inflation have on the assessment of future pensions and investment income?

    <p>It becomes difficult to assess their real value</p> Signup and view all the answers

    What is the primary focus of the Bureau of Labor Statistics in the US?

    <p>Producing national statistics on measures of inflation</p> Signup and view all the answers

    How is the base year for calculating changes in the 'shopping basket' determined?

    <p>By setting a year with a total cost of the 'shopping basket' as an index of 100</p> Signup and view all the answers

    What determines the rate of sustainable growth in an economy in the long run?

    <p>The growth and productivity of the labor force</p> Signup and view all the answers

    Which organization publishes international standards for calculating the Consumer Price Index (CPI)?

    <p>International Monetary Fund (IMF)</p> Signup and view all the answers

    What is typically included in the Gross Domestic Product (GDP) calculation?

    <p>Consumer spending plus government spending plus investment plus exports minus imports</p> Signup and view all the answers

    What does GDP measure?

    <p>The value of total output generated by firms</p> Signup and view all the answers

    What is the primary goal of using inflation measures like the CPI?

    <p>To measure average changes in prices paid by consumers</p> Signup and view all the answers

    How often is GDP typically calculated?

    <p>Quarterly</p> Signup and view all the answers

    What positive aspect of high inflation is mentioned in the text?

    <p>Erosion of the real value of national debt</p> Signup and view all the answers

    What is a potential consequence of deflation in an economy, as discussed in the text?

    <p>High unemployment rates and worsening economic conditions</p> Signup and view all the answers

    Which entity uses interest rates to control inflation according to the text?

    <p>Central banks</p> Signup and view all the answers

    What is the primary reason behind central banks raising interest rates in an economy?

    <p>Slowing spending and reducing inflation</p> Signup and view all the answers

    What is one of the risks associated with deflation as discussed in the text?

    <p>Depression and reduced borrowing</p> Signup and view all the answers

    How do central banks control inflation through interest rates?

    <p>Raising rates to slow spending and reduce inflation</p> Signup and view all the answers

    In what situation would a central bank reduce its official interest rate?

    <p>To stimulate economic growth</p> Signup and view all the answers

    Which entity benefits from rising asset prices due to high inflation?

    <p>'Feel-good' factor asset owners</p> Signup and view all the answers

    How do annual inflation rates impact the purchasing power of a country's currency?

    <p>Reduce the purchasing power of the currency</p> Signup and view all the answers

    What is the primary reason behind central banks looking ahead when deciding on monetary policy?

    <p>To consider long-term impacts on economic variables</p> Signup and view all the answers

    What happens to the value of a US dollar-denominated asset owned by a UK investor if the US dollar depreciates relative to sterling?

    <p>Decreases</p> Signup and view all the answers

    Which exchange rate regime involves no intervention from the central bank and is determined by demand and supply forces?

    <p>Managed float</p> Signup and view all the answers

    What is the main difference between a target zone and a crawling peg exchange rate regime?

    <p>Gradually widening bands vs. Managed within a band</p> Signup and view all the answers

    Under which exchange rate regime does the central bank only intervene if upper or lower limits for the rate are breached?

    <p>Target zone</p> Signup and view all the answers

    Which exchange rate regime is sometimes referred to as a 'dirty' float due to occasional central bank intervention?

    <p>Managed float</p> Signup and view all the answers

    What is a notable characteristic of a crawling peg exchange rate regime compared to a fixed rate system?

    <p>'Free' floating vs. Pegged to currency</p> Signup and view all the answers

    What is a key factor that contributes to long-term productivity growth, according to the text?

    <p>Utilisation of labour-saving new technology</p> Signup and view all the answers

    In the context of economic cycles, what term is used to describe an economy growing above its trend growth rate?

    <p>Inflationary consequences</p> Signup and view all the answers

    Which component of the balance of payments is used to calculate the total value of goods and services flowing into and out of a country?

    <p>Current account</p> Signup and view all the answers

    What does a current account deficit indicate in terms of a country's trade balance?

    <p>Importing more than exporting</p> Signup and view all the answers

    Which international capital transaction category involves trading in stocks and bonds?

    <p>Portfolio investment</p> Signup and view all the answers

    What can happen if a country's exchange rate rises, according to the text?

    <p>Decrease in exports competitiveness</p> Signup and view all the answers

    How is a trade deficit defined in the balance of payments context?

    <p>Value of imports exceeding value of exports</p> Signup and view all the answers

    What is the key function of government in managing public finances?

    <p>Controlling national debt</p> Signup and view all the answers

    How does a budget surplus affect government borrowing?

    <p>Reduces the need for borrowing</p> Signup and view all the answers

    What does a high level of public borrowing and debt risk?

    <p>Undermining economic stability</p> Signup and view all the answers

    In a buoyant economy, why is government spending typically less than income?

    <p>Due to high tax revenues</p> Signup and view all the answers

    What are the two main types of economic indicators discussed in the text?

    <p>Budget deficit and government debt</p> Signup and view all the answers

    How do higher levels of unemployment affect a government's finances?

    <p>Increase welfare payments</p> Signup and view all the answers

    What is the 'natural rate of unemployment' referring to in the context of the text?

    <p>The level of unemployment when demand matches supply</p> Signup and view all the answers

    How are exchange rates affected by an appreciation of one currency?

    <p>The other currency depreciates</p> Signup and view all the answers

    Why is it important for governments to reduce public sector borrowing in a buoyant economy?

    <p>To prevent inflation from rising</p> Signup and view all the answers

    Study Notes

    The Economic Environment

    • The economic environment consists of various factors that influence the financial services sector.
    • Economic activity is determined by factors such as natural resources, skilled workforce, and government policies.

    Factors Determining Economic Activity

    • There are two main categories of factors that affect economic growth: demand-side factors (e.g., consumer spending) and supply-side factors (e.g., productive capacity).
    • Governments raise finance for public expenditure through taxes, indirect taxes, and borrowing in the capital markets.

    Economic Systems

    • There are three main types of economic systems: planned economy, market economy, and mixed economy.
    • A planned economy is controlled by the government, which decides what and how to produce.
    • A market economy is driven by supply and demand, where businesses produce goods and services to meet consumer demand.
    • A mixed economy combines elements of both planned and market economies.

    Open Economies

    • An open economy has few barriers to trade or controls over foreign exchange.
    • Open economies can be either market-oriented or mixed economies.
    • The World Trade Organization (WTO) promotes free trade between economies and arbitrates disputes.

    The Economic Cycle

    • The economic cycle consists of four stages: peak, contraction, trough, and expansion.
    • The stages of the economic cycle are characterized by changes in GDP, with peak being the highest point, contraction being the decline, trough being the lowest point, and expansion being the growth phase.
    • Fiscal and monetary policies are used to stabilize the economy during the economic cycle.

    Fiscal Policy

    • Fiscal policy involves government spending and taxation to influence the level of economic activity.
    • Fiscal policy can be expansionary (loose) or contractionary (tight), depending on the stage of the economic cycle.
    • Tools of fiscal policy include the budget, taxation, and government spending.

    Monetary Policy

    • Monetary policy regulates the economy through control of the monetary system.
    • Monetary policy involves control of the money supply, interest rates, and credit conditions.
    • Tools of monetary policy include reserve requirements, interest rates, and credit controls.

    Central Banks

    • Central banks operate at the center of a nation's financial system.
    • Central banks are guided by the Bank for International Settlements (BIS).
    • Central banks have responsibilities such as acting as banker to the government, regulating the banking system, and managing the national debt.
    • Central banks also influence the value of a nation's currency and provide a depositors' protection scheme.

    Macroeconomic Policy

    • Macroeconomic policy aims to influence the performance of the economy as a whole.
    • Macroeconomic policy objectives include full employment, low inflation, and balance of payments equilibrium.
    • Macroeconomic policy tools include fiscal and monetary policy.
    • Macroeconomic policy varies depending on the stage of the economic cycle.### Central Banks
    • The Federal Reserve System (Fed) in the US:
      • Comprises 12 regional Federal Reserve Banks
      • Monitors banks and provides liquidity
      • Federal Open Market Committee (FOMC) makes decisions to promote price stability and sustainable economic growth
      • Meets every 6 weeks to examine economic data and determine if the Fed funds rate should be altered
    • European Central Bank (ECB):
      • Based in Frankfurt
      • Responsible for setting monetary policy for the eurozone
      • Objective is to maintain internal price stability
      • Influences factors that affect inflation, such as the external value of the euro and growth in the money supply
    • Bank of England (BoE):
      • Founded in 1694
      • Gained operational independence in 1997
      • Monetary Policy Committee (MPC) sets monetary policy
      • Primary focus is to ensure inflation is kept within a government-set range
    • Bank of Japan (BoJ):
      • Founded in 1882
      • Gained operational independence in 1997
      • Responsible for monetary policy and issuing and managing the external value of the Japanese yen

    Budget Deficits and National Debt

    • Key function of government is to manage public finances
    • Key economic indicators: public sector debt (national debt) and budget deficit
    • Debt measures are presented as a percentage of GDP
    • Budget deficit is the difference between government expenditure and government income
    • In a buoyant economy, government spending is less than income, and substantial tax revenues are generated
    • In a slowing economy, government spending exceeds tax revenues, and the government must raise borrowing by issuing government bonds

    Level of Unemployment

    • Extent of unemployment indicates the health of the economy
    • Natural rate of unemployment exists due to people seeking new jobs, returning to the workforce, or lacking skills
    • Higher levels of unemployment indicate low demand for goods and services and people
    • High unemployment levels negatively impact government finances due to increased social security payments and decreased tax revenues

    Exchange Rates

    • Exchange rate is the price of one currency in terms of another
    • Changes in exchange rates affect economic activity and investment decisions
    • Appreciation of a currency (e.g., USD) against another currency (e.g., EUR) makes exports cheaper and imports more expensive
    • Exchange rate regimes:
      • Fixed rate system: exchange rate is pegged to a particular currency
      • Floating rate system: exchange rate is determined by demand and supply
      • Target zone: exchange rate is managed within a band
      • Crawling peg: exchange rate is gradually adjusted
      • Managed float: exchange rate is largely floating, with occasional intervention

    Economic Indicators

    • Key indicators:
      • Gross domestic product (GDP)
      • Balance of payments
      • Budget deficit/surplus
      • Level of unemployment
      • Exchange rates
      • Inflation/deflation
    • Inflation:
      • Persistent increase in general price levels
      • Caused by excess demand, scarcity of resources, and government spending
      • High levels of inflation can cause problems for businesses, employees, and savers
      • Governments seek to control inflation at a level of about 2-3% per annum
    • Deflation:
      • General fall in price levels
      • Can cause high unemployment, reduced spending, and a reluctance to borrow
      • Can lead to a vicious circle of reduced spending and a decreasing burden of debt

    Gross Domestic Product (GDP)

    • Measures economic activity on an expenditure basis
    • Calculated quarterly
    • Can be measured in three ways:
      • Total income paid by firms to individuals
      • Individuals' total expenditure on firms' output
      • Value of total output generated by firms
    • GDP is the most commonly used measure of a country's output

    Inflation Measures

    • Consumer price index (CPI) measures changes in prices to estimate the average level of prices in the economy
    • CPI is a basket of typical goods and services consumed by households
    • Weights are attached to items in the basket reflecting their importance in a typical household budget
    • Inflation rate is the percentage change in the latest index compared with the value recorded 12 months previously### Economic Growth
    • Long-term productivity growth is dependent on education and training, and the utilization of labor-saving new technology
    • The US's long-term trend rate of economic growth has averaged nearly 3%
    • Developing economies can experience economic growth rates of up to 10% per annum

    The Economic Cycle

    • The economic cycle, or business cycle, arises from the deviation of actual growth from trend growth in the short term
    • When an economy is growing in excess of its trend growth rate, actual output exceeds potential output, often with inflationary consequences
    • When a country's output contracts, it is said to be in recession, or entering a deflationary period, resulting in spare capacity and unemployment

    Balance of Payments (BoP)

    • The BoP is a summary of all transactions between a country and the rest of the world
    • If a country imports more than it exports, there is a BoP deficit, and if it exports more than it imports, there is a BoP surplus

    Components of the Balance of Payments

    • Trade balance: the difference between the value of imported and exported goods (visible trade balance) and services (invisible trade balance)
    • Current account: the total value of goods and services that flow into and out of a country, including trade balance figures, dividends, and remittances
    • Capital account: international capital transactions related to investment in business, real estate, bonds, and stocks

    Exchange Rates

    • The 'right' exchange rate is critical to the level of international trade, international competitiveness, and a country's economic position
    • If a country's exchange rate rises, exports will be less competitive, unless producers reduce their prices, and imports will be cheaper and more competitive

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    Explore the chapter discussing the broader economic environment in the financial services sector. Learn about economic activity determination in different economic and political systems, stages of the economic cycle, government's role in economic policy, and the management of economic activities by governments and central banks.

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