Economic Environment

Economic environment
The four major objectives are:
 Full employment
 Price stability
 A high, but sustainable, rate of economic growth
 Keeping the Balance of Payments in equilibrium.
Full Employment
Full employment was considered very important after the Second World War.
Unemployment in the 80s was seen as an inevitable consequence of the steps taken to make
industry more efficient.
De-industrialisation made higher unemployment feel inevitable, and so this objective became much
less important than it had been.
Growth & Low Inflation
Growth and low inflation have always been important.
Without growth peoples’ standard of living will not increase, and if inflation is too high then the
value of money falls negating any increase in living standards.
Sustainable growth means growth without inflation.
Balance of payments
The total of all the money coming into a country from abroad less all of the money going out of the
country during the same period.
Policies to reduce a BOP deficit:
1. Higher Interest Rates
- will act to slowdown the growth of consumer demand and therefore lead to cutbacks in the
demand for imports.
2. Fiscal policy
(i.e. increases in direct taxes) might also be used to reduce aggregate demand.
The risk is that a sharp fall in consumer spending might lead to a steep economic slowdown (slower
growth of GDP) or an full-scale recession
Decisions relating to taxation and government spending with the aim of full employment, price
stability, and economic growth. (Fiscal Policy)
Discussion:
By changing tax laws, the government can alter the amount of disposable income available to its
taxpayers. If taxes increased consumers would have less money to spend.
This difference in disposable income would go to the government instead of going to consumers,
who would pass the money onto companies.
Or, the government could increase its spending by purchasing goods from companies. This would
increase the flow of money through the economy and would eventually increase the disposable
income available to consumers.
Unfortunately, this process takes time, as the money needs to wind its way through the economy,
creating a significant lag between the implementation of fiscal policy and its effect on the economy.
Governments can borrow:
• Short-term, e.g. Treasury bills
• Long-term, e.g. National Savings certificates.
This can have bad effects on the economy by ‘crowding out’ private investment by pushing up
interest rates
BUT: government spending can also boost the economy
The regulation of the money supply and interest rates by a central bank in order to control
inflation and stabilise currency (Monetary Policy)
Monetary policy is one of the ways the government can impact the economy.
By impacting the effective cost of money, the government can affect the amount of money that is
spent by consumers and businesses.
 Affect on Growth
When interest rates are high, fewer people and businesses can afford to borrow, so this usually
slows the economy down.
Also, more people will save (if they can) because they receive more on their savings rate.
When the central banks set interest rates it is the amount they charge other banks to borrow
money.
This is a critical interest rate, in that it affects the entire supply of money, and hence the health of
the economy.
High interest rates can cause a recession.
 Affect on Exchange rates
High interest rates attracts foreign investment ⇨ increase in exchange rates:
• exports dearer
• imports cheaper.
 Effect on Inflation
High interest rates should restrict growth and inflation
Competition policy
The Competition Commission prevents takeovers that are against the public interest
Competition policy aims to ensure:

 Wider consumer choice
 Technological innovation, and
 Effective price competition
Government assistance for business
Government grants available for certain investments and small business in areas such as rural
development, energy efficiency, education etc
Green policies
Airfuel tax for example can threaten an airline business but create opportunities for other forms of
transport or makers of new greener aircraft.
A financial intermediary is an entity who performs intermediation between two parties
This means that the lender gives money to the borrower indirectly as the financial intermediary sits
in between.
It is typically an institution that allows funds to be moved between lenders and borrowers.
It works as follows:
 Savers (lenders) give funds to

 An intermediary institution (such as a bank), who then gives those funds to
 Spenders (borrowers)
This may be in the form of loans or mortgages.
The Roles include
(a) Aggregating investments to meet needs of borrowers
To provide a link between many investors who may have small amounts of surplus cash and fewer
borrowers who may need large amounts of cash
(b) Risk transformation
Intermediaries offer low-risk securities to primary investors to attract funds, which are then used to
purchase higher-risk securities issued by the ultimate borrowers
(c) Maturity transformation
Investors can deposit funds for a long period of time while borrowers may require funds on a short-
term basis only, and vice versa. In this way the needs of both borrowers and lenders can be satisfied.
A stock market (also known as a stock exchange) has two main functions
1. to provide companies with a way of issuing shares to people who want to invest in the
company
2. to provide a venue for the buying and selling of shares
The first function allows businesses to be publicly traded, or raise additional capital for expansion by
selling shares of ownership of the company in a public market
This enables investors the ability to quickly and easily sell securities.
This liquidity is an attractive feature of investing in stocks, compared to other less liquid investments
such as real estate
Exchanges also act as the clearinghouse for each transaction, meaning that they collect and deliver
the shares, and guarantee payment to the seller of a security
This eliminates the risk to an individual buyer or seller.
The Alternative Investment Market is regulated by the London Stock Exchange.

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Economic environment

The four major objectives are:

Growth & Low Inflation

Growth and low inflation have always been important.

Sustainable growth means growth without inflation.

Policies to reduce a BOP deficit:

1. Higher Interest Rates

Governments can borrow:

• Short-term, e.g. Treasury bills

• Long-term, e.g. National Savings certificates.

BUT: government spending can also boost the economy

High interest rates can cause a recession.

 Affect on Exchange rates

High interest rates attracts foreign investment ⇨ increase in exchange rates:

High interest rates should restrict growth and inflation

Competition policy aims to ensure:

Government assistance for business

A financial intermediary is an entity who performs intermediation between two parties

 Savers (lenders) give funds to

This may be in the form of loans or mortgages.

The Roles include

(a) Aggregating investments to meet needs of borrowers

(b) Risk transformation

(c) Maturity transformation

This eliminates the risk to an individual buyer or seller.

The Alternative Investment Market is regulated by the London Stock Exchange.

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