Economics- Edexcel 4.4.3
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| Main functions of a central bank | monetary policy function, financial stability and regulatory function, policy operation functions, debt management
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| monetary policy function | setting base rate, deciding on QE, possible exchange rate intervention in managed floating or fixed
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| 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
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| policy operation functions | lender of last resort, managing liquidity, overseeing the payments systems
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| debt management | handling government debts
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| Main aim of bank of england | promote monetary and financial stability
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| Monetary stability means | stable prices and confidence in the currency
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| Monetary policy committee | look at a range of demand/supply-side indicators that impact inflationary pressures and decide the policy interest rates
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| MPC | monetary policy committee
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| 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
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| Deflationary monetary policies | higher interest rates on both loans and savings, tightening of credit supply, appreciation of the external value of the exchange rate
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| Aim of expansionary monetary policy | increase AD
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| Aim of deflationary monetary policy | lower AD
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| 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
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| 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
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| 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
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| 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
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| yield | how much income an investment generates, separate from the principal
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| Main channels through which QE is supposed to work | wealth effect, borrowing cost effect, lending effect, currency effect
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| 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
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| borrowing cost effect | QE lowers the interest rate on long term debt
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| lending effect | QE increases the liquidity of banks and increased lending from banks lifts incomes and spending in the economy
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| currency effect | lower interest rates have the side effect of causing the exchange rate to weaken which helps exports
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| Main regulators of the UK financial system | FPC, PRA, FCA, CMA
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| FPC | financial policy committee
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| PRA | prudential regulation authority
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| FCA | financial conduct authority
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| CMA | competition and markets authority
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| 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
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| Main role of FPC | identify, monitor and take actions to remove or reduce risks that threaten the resilience of the UK financial system
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| What does the FPC do? | publish a financial stability report, instruct commercial banks to change their capital reserve ratios
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| 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
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| Macro-prudential policy | aim to increase the financial system's resilience to shocks by addressing identified systemic risks
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| Micro-prudential policy | adjusts capital based on individual institutions' risks
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| Main role of PRA | responsible for the prudential regulation and supervision of around 1700 banks, building societies, credit unions, insurers and major investment firms
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| PRA is particularly focused on solvency of specific financial markets like | insurance providers, buy-to-let mortgage lenders, credit unions
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| Liquidity ratio | ratio of liquid assets held by a bank on their balance sheet to their overall assets
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| Basel agreement | requires commercial banks to keep enough liquid assets to get through a 30 day market crisis
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| Liquid asset ratio formula | cash & balances with central banks + government bonds / bank’s total assets
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| 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
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| 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
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| Counter cyclical capital buffer rate in UK | 2%
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| Counter cyclical capital buffer rate parts | upswing in credit cycle, downswing in credit cycle
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| Upswing in credit cycle | commercial banks are required to build up extra capital reserves
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| Downswing in credit cycle | commercial banks have more capital to help absorb losses
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| Leverage ratio | indicator of the ability of a bank or building society to absorb losses
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| Leverage ratio formula | capital / exposures
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| Lower leverage ratio | more that the bank or building society relies on debt to fund their activities
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| 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
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| Stress tests use what? | tail end risks
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| Tail end risks | economic outcomes that lie well outside the mainstream forecasts
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