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Economics 4.4.3

Economics- Edexcel 4.4.3

TermDefinition
Main functions of a central bank monetary policy function, financial stability and regulatory function, policy operation functions, debt management
monetary policy function setting base rate, deciding on QE, possible exchange rate intervention in managed floating or fixed
financial stability and regulatory function supervision of stability of wider financial system to reduce systemic risk, prudential policies designed to maintain financial stability during times of crisis and high volatility
policy operation functions lender of last resort, managing liquidity, overseeing the payments systems
debt management handling government debts
Main aim of bank of england promote monetary and financial stability
Monetary stability means stable prices and confidence in the currency
Monetary policy committee look at a range of demand/supply-side indicators that impact inflationary pressures and decide the policy interest rates
MPC monetary policy committee
Expansionary monetary policies reducing nominal and real interest rates, expand the supply of credit from the banking system, depreciation of the external value of the exchange rate
Deflationary monetary policies higher interest rates on both loans and savings, tightening of credit supply, appreciation of the external value of the exchange rate
Aim of expansionary monetary policy increase AD
Aim of deflationary monetary policy lower AD
Liquidity trap when the nominal interest rate is close or equal to zero and central banks find that they have run out of room to stimulate AD during a slowdown or recession
Why might a liquidity trap happen? risk averse banks are required to hold more capital and charge a premium on new loans/private sector businesses and consumers are low on confidence and focussed on cutting their existing debt rather than taking out new loans
How to overcome a liquidity trap fiscal policy(larger budget deficit for AD)/central banks supply or use negative interest rates to reduce real interest rates/switch to a managed floating exchange rate to seek competitive depreciation
Quantitative easing Bank of England creates new money to buy assets, increased demand for gov bonds increases prices, causes a fall in the yield on a bond, use money from sold bonds to buy other assets causing injection of cash
yield how much income an investment generates, separate from the principal
Main channels through which QE is supposed to work wealth effect, borrowing cost effect, lending effect, currency effect
wealth effect people spend more as the value of their assets rise. The idea is that consumers feel more financially secure and confident about their wealth when their homes or investment portfolios increase in value
borrowing cost effect QE lowers the interest rate on long term debt
lending effect QE increases the liquidity of banks and increased lending from banks lifts incomes and spending in the economy
currency effect lower interest rates have the side effect of causing the exchange rate to weaken which helps exports
Main regulators of the UK financial system FPC, PRA, FCA, CMA
FPC financial policy committee
PRA prudential regulation authority
FCA financial conduct authority
CMA competition and markets authority
Main aims of financial market regulation protect against market failure/encourage confidence/allow Central Bank to perform its other roles/prevent systemic risk within financial markets
Main role of FPC identify, monitor and take actions to remove or reduce risks that threaten the resilience of the UK financial system
What does the FPC do? publish a financial stability report, instruct commercial banks to change their capital reserve ratios
What does the fpc say when risks to the financial system are growing? tell commercial banks and other lenders to increase their capital buffet to help absorb unexpected losses on their assets
Macro-prudential policy aim to increase the financial system's resilience to shocks by addressing identified systemic risks
Micro-prudential policy adjusts capital based on individual institutions' risks
Main role of PRA responsible for the prudential regulation and supervision of around 1700 banks, building societies, credit unions, insurers and major investment firms
PRA is particularly focused on solvency of specific financial markets like insurance providers, buy-to-let mortgage lenders, credit unions
Liquidity ratio ratio of liquid assets held by a bank on their balance sheet to their overall assets
Basel agreement requires commercial banks to keep enough liquid assets to get through a 30 day market crisis
Liquid asset ratio formula cash & balances with central banks + government bonds / bank’s total assets
Commercial bank’s capital ratio measures the funds a bank has in reserve against the riskier assets it holds that could be vulnerable in the event of a crisis
undistributed profits the portion of a company's net income that is not paid out as dividends to shareholders but is instead retained within the company for various purposes
Counter cyclical capital buffer rate in UK 2%
Counter cyclical capital buffer rate parts upswing in credit cycle, downswing in credit cycle
Upswing in credit cycle commercial banks are required to build up extra capital reserves
Downswing in credit cycle commercial banks have more capital to help absorb losses
Leverage ratio indicator of the ability of a bank or building society to absorb losses
Leverage ratio formula capital / exposures
Lower leverage ratio more that the bank or building society relies on debt to fund their activities
Stress tests assess commercial banks’ ability not just to withstand severe shocks but to maintain the supply of credit to the real economy under severe pressure
Stress tests use what? tail end risks
Tail end risks economic outcomes that lie well outside the mainstream forecasts
Created by: jessharris
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