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CISI Course - Chapter 2


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A closed economy (state controlled or planned)
1. Economy is centrally organised
2. State decides what visibles - consumer goods - are available
3. State also decides what invisibles - services, e.g. health care - are available.
4. Common post-WW2 era - Soviet Union
5. 21st century - North Korea, Cuba

Market economic system
- A true market economy is largely theoretical
- would demand the provision of all goods and services be undertaken by private individuals/companies responsible to shareholders.
- Purely governed by consumer demand
- Closest is the USA, but that isn't 100% market - police for example.

Mixed economic systems
- Majority of modern economies are mixed
- State remains responsible for provision of public services, health, education, defence.
- However, what were considered vital national industries are now privatised, e.g. power, transport and telecommunications.

How do mixed economic systems raise resources?
1. Levying taxes, e.g. income tax, corporation tax.
2. levying indirect taxes, e.g. VAT and excise duty
3. issuing debt securities (gilts) - Financial crisis.

China has recently become much more mixed.

Open economic systems
- Largely theoretical
- States that have protectionistic agendas are contrary to this system
- World Trade Organisation has a duty to promote free trade and can impose economic sanctions - these would inevitably be politically motivated

What is the Bank of England known as?
\'The Bank\'
What is \'Fiscal policy\'? (4)
1. Government balances its income and spending
2. Cost of public services is paid for by raising taxes/borrowing
3. This generates the budget
4. Department responsible - The treasury

What is \'monetary policy\'? (2)
1. Process which controls the supply of money in the economy
2. Through setting interest rates and supply of credit

Describe the treat of inflation (2)
1. the cheaper the cost of credit, the more likely that spending and prices will spiral out of control.
2. Traditionally relaxed before and election
What was the first thing the labour party did in 1997?
Granted the Bank independent control over the setting of interest rates.
Why was the Bank granted independent control
So non-political financial experts can take a long term view of the economy.
How and when does the Bank set interest rates? (2)
1. A monthly meeting of the Bank\'s Monetary Policy Committee
2. (MPC) is made up of nine members whose deliberations are made public
What are the Bank\'s two core purposes? (2)
1. Monetary Stability
2. Financial Stability
How does the Bank achieve its two core purposes?
It has 3 strategic priorities
What is the Bank\'s first strategic priority? (2)
1. Keep inflation to 2% or below this creates monetary stability.
2. Properly communicate decisions to the public
What is the Bank\'s second strategic priority? (1)
1. Have in place the tools and operating functionality to ensure inter-bank lending liquidity and collateral management by providing liquidity insurance.
What is the Bank\'s third strategic priority? (3)
1. Involve itself in major international debates on structures for the global financial system
2. Promote simpler and stronger regimes for regulation of capital flows
3. More stringent regulation of market infrastructures


What are the Bank\'s further responsibilities (3)

1. Intervening in FX market to stabilise the price of sterling
2. Acting as lender or last resort
3. Responsible for cash in circulation


What are the Bank\'s further responsibilities? (3)

4. Responsible for the nation\'s FX and bullion reserve (Gold)
5. Preparation of economic statistics, e.g. GDP, RPI
6. Acting as the Govt\'s bank - responsible for issuing Govt debt

Describe the Federal Reserve (the FED) (5)
1. USA\'s equivalent of the Bank
2. Longer history of monetary independence
3. Headquarters in Washington DC
4. Branches across USA
5. Federal Open Market Committee (MPC\'s equivalent)

Describe Bank of Japan
Performs a similar function to the Bank and Fed
Describe the European Central Bank (ECB) (2)
1. Based in Frankfurt
2. Responsible for monetary policy throughout the Eurozone
Who regulates financial markets in the West? (3)
1. Independent authorities
2. FSA (UK)
3. Securities and Exchange Commission (USA)

What role to governments play now? (2)
1. Try to achieve greater levels of harmonisation
2. Integration of global securities regulation
How to domestic transactions take place? (4)
1. Electronic transactions - CHAPS
2. Bills of Exchange (cheques)
3. Credit and debit cards
4. Cash

Describe the credit creation process (2)
1. Retail banks lend saved money to people who need it and charge a higher rate of interest
2. Banks can be forced to hold 25% of lending ability, this technically means that for every £25.00 deposited the money supply can increase to £100.00
What is inflation?
A persistent increase in the general price of goods and services.
What can cause inflation? (2)
1. Too much money in the system
2. Shortage of goods and services

What are the disadvantages of inflation? (2)

1. Uncertainty regarding the true value of investments made for the future (e.g. pensions and endowments) may act as a disincentive to save.
2. Businesses continually increase prices to keep ahead of inflation

What are the disadvantages of inflation? (2)

3. Wage demands will increase as employees see their actual spending power reduced
4. Exports become more expensive to foreign consumers as wage and commodity price rise.
What is the advantage to inflation? (1)
1. Real value of a country’s debt declines
Describe the Retail Price Index (RPI) (2)
1. Basket of everyday goods and services
2. Cost is compared month on month
Describe RPIX (2)
1. Basically RPI except mortgage payments
2. Truer picture of underlying trends given that interest rates - variable rate mortgages can change
Describe Harmonised Index of Consumer Prices (HICP) (1)
1. RPI measure applied to prices of similar goods and services across the EU

Describe the Consumer Price Index (CPI)(2)
1. EU wide measure that excludes all housing costs
2. Govt wants to change pensions from being linked to RPI to CPI - pensioners would be worse off.
Describe Gross Domestic Profit (GDP)(1)
1. Politicians that refer to growth generally refer to GDP
How is Gross Domestic Profit calculated? (4)

1. Consumer spending +
2. Govt spending +
3. Investment (savings, corporate spending) +
4. Exports - Imports = GDP

Describe Gross National Product (2)

1. Looks at the flow of investment income to and from international entities.
2. If foreign investors take more out then we do GNP will be lower
Describe Balance of Payment (BOP) (3)

1. Imports vs exports
2. Import more than export - negative
3. UK - net importer of visibles, exporter of invisibles = services.


Describe sources of growth (3)

1. Increases in both the size and the productivity of the labour force
2. Efficiency of the basic economic system - private investment
3. Investment in infrastructure projects hopefully increases efficiency

Describe growth and recession (2)

1. Where actual growth exceeds the trend may be inflationary,
2. Where negative growth (compared to the trend rate) occurs for 2 consecutive quarters will be recessionary
In terms of Balance of Payments, exporting more than we import is known as a ...
trade surplus
In terms of Balance of Payments, importing more than we export is known as a ...
trade deficit
What is a balance of payment\'s current account? (3)
1. Actual/goods/services flowing in and out of the country +
2. Dividends from assets owned abroad +
3. Tax revenues from Britons working abroad

What is a balance of payment\'s capital account? (2)
1. Records investment in and out of the usual asset groups (property, shares, bonds etc).
2. Doesn\'t record the future regular repayments/dividends that the loans and investments yield; will be recorded in the current account eventually
For the BOP to actually be in balance ...
the current account should equal the capital account.
What are foreign currency fluctuations? (2)
1. If Sterling rises in value against the Euro then British exports become more expensive in the Eurozone
2. Whilst imports from the Eurozone become cheaper
What was Public Sector Net Cash Requirement called and what is it? (2)
1. difference between the amount the govt raises through taxation and the amount it spends on services
2. formerly called Public Sector Borrowing Requirement
How is the Public Sector Net Cash Requirement used to indicate economic health? (3)
1. If the figure is positive.
2. This means that government will not need to borrow as tax revenue exceeds spending
3. Lowering taxation levels can have a positive effect on this measure.

How does unemployment affect the UK economy? (1)
High unemployment means that less people are contributing taxes and instead are claiming benefits.
What are exchange controls? (1)
1. State(s) try to control the rates of exchange between different currencies
What are the benefits of the Euro? (2)
1. Tourists and businesses are all paying and receiving the same coinage
2. Creates a single and relatively simple marketplace.
What are the disadvantages of the Euro?
1. Lack of national identity
2. Interests rates set only by ECB - economic circumstances differ.

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