S-Cool Revision Summary

S-Cool Revision Summary

Appreciation

This is the term used for a gradual rise in the value of a currency in a floating exchange rate system, as opposed to a revaluation, which is a large rise in the value of a currency, usually when it is realigned within a fixed exchange rate system.

Balance of payments

This is a record of all the flows of money into, and out of, the UK over a given time period (usually a year). It is split into two: the Current Account (exports and imports of goods and services) and the Capital Account (flows of money for investment plus government reserves of foreign currencies).

Bretton Woods exchange rate system

In 1948, the Bretton Woods conference was one of the most important of the century. Not only did they set up the International Monetary Fund (IMF) and the General Agreement on Tariffs and Trade (GATT, which became the World Trade Organisation), but they set up a fixed exchange rate system which gave the international monetary system much stability over the next twenty years.

Budget deficit

This is a short phrase used to describe the Public Sector Net Cash Requirement (PSNCR). It refers to the government's budget being in deficit. This should not be confused with the trade deficit, which is the deficit in the 'trade in goods' part of the current account of the balance of payments (for example, the value of imports of goods are higher than the value of exports of goods).

Capital account

This is the commonly used name for the Capital and Financial account of the balance of payments.

Capital and Financial account

This is one half of the balance of payments. It measures all flows of money into and out of a country for the purpose of direct investment and portfolio investment. It also includes the government's foreign reserves and money borrowed and lent across boundaries in the banking sector.

Current account

This is one half of the balance of payments. It measures all exports and imports of goods and services for a given country. It also includes investment income and transfers.

Current account deficit

If a country has a deficit on their current account then it means that it imports more goods and services (in terms of value) than it exports.

Current account surplus

If a country has a surplus on their current account then it means that it exports more goods and services (in terms of value) than it imports.

Depreciation

This is the term used for a gradual fall in the value of a currency in a floating exchange rate system, as opposed to a devaluation, which is a large fall in the value of a currency, usually when it is realigned within a fixed exchange rate system.

Devaluation

A devaluation is a large, and often immediate, fall in the value of a currency. The pound fell by around 15% in value when it dropped out of the ERM in September 1992.

Direct investment

This refers to any investment in a business in another country. Basically it refers to the transfer of ownership of UK and foreign businesses. If Marks & Spencer set up a new store in France, the money invested appears in this section of the capital account as an outflow of money (-). If the French car company Renault set up a factory in the UK, the money invested appears in this section of the capital account as an inflow of money (+).

Economies of scale

Quite simply, this refers to 'economies' made by firms or industries as a result of increasing in 'scale'. In other words, as a firm gets bigger, its average cost tends to fall because of things like bulk buying, specialisation and spreading administrative costs.

Effective exchange rate

This is the economists' term for the trade weighted index. See the relevant glossary entry for details.

Elastic demand

The demand for a good is relatively elastic when, for a given percentage change in its price, the percentage change in the quantity demanded is larger. Goods with lots of substitutes tend to have relatively elastic demand (for example, a type of chocolate bar).

Euroland

This refers to the countries that have adopted the euro. At the moment, there are eleven countries in Euroland.

European Central Bank (ECB)

This is the new central bank that is in charge of monetary policy for the whole of Euroland. Not only does it set interest rates, but it also sets the inflation target that the manipulation of interest rates helps achieve. This target is currently 2% or less.

European Monetary Union (EMU)

This is the term used for the three stage process that culminated in the introduction of the euro on the 1st January 1999. For details, see the QuickLearn called 'The euro'.

Exchange Rate Mechanism (ERM)

This is the fixed (but adjustable) exchange rate system for EU currencies. In began in 1979 (without the UK). Currencies were fixed to a central rate (a weighted average of all the currencies), but countries were allowed to vary their exchange rate within a two and a quarter percent band. Realignments were allowed in exceptional circumstances. The UK joined in 1990 at too high a rate. The £ was allowed a 6% band, but it didn't help much. The £ was at the bottom of this band for most of 1992, and was forced out in September. Those currencies that survived the turmoils of 1992 and 1993 stayed in the ERM until their currencies were subsumed into the euro in January 2000.

Floating exchange rates

This is when a currency is not part of a fixed exchange rate system, and so it 'floats' on the currency markets. Its value, therefore, is determined by the supply and demand of the currency due to capital flows, both long and short term, as well trade.

Foreign Direct Investment (FDI)

As the title suggests, this refers to direct investment from abroad. A good example is when Nissan built a car factory in Sunderland in the 80s.

Gross Domestic Product (GDP)

GDP is a measure of the size of an economy. It can be measured using three methods. One can add up all the output (of goods and services) in an economy; one can add up all the expenditure (on the goods and services) in the economy or one can add up all the incomes earned (used to spend on the goods and services) in the economy. See the topic called 'Aggregate demand and aggregate supply' for more detail.

Headline rate of inflation

This is the inflation rate calculated from the Retail Price Index (RPI).

Hot money

This refers to very short term capital flows that move quickly around the world to gain the best short term interest rates. When speculators buy and sell currency for a quick profit the money they use can also be defined as 'hot money'.

Index series

An index series is a set of numbers with no units that are used to measure the relative changes in a statistic from one time period to another. All of these 'numbers' are set against a base year, or base month, which is always 100. For example, the Retail Price Index (RPI) has no units. The percentage difference between each monthly 'number' and the last is the percentage change in the average price level for a given basket of goods and services.

Inelastic demand

The demand for a good is relatively inelastic when, for a given percentage change in its price, the percentage change in the quantity demanded is smaller. Goods with very few substitutes tend to have relatively inelastic demand (for example, petrol).

Inflation

Inflation is usually defined as a sustained rise in the general level of prices. Technically, it is measured as the annual rate of change of the Retail Price Index (RPI). It is often referred to as the headline rate of inflation.

International Monetary Fund (IMF)

This institution was set up in 1948 to manage the international monetary system and the Bretton Wood fixed exchange rate system. All major countries contribute some money to the fund. The IMF then uses this money to stop struggling countries collapsing when they run out of foreign reserves. Although the major countries never need to call upon the IMF, it is important for them that other countries do not collapse. After all, they need markets for their goods!

J-curve

The J-curve illustrates the phenomenon whereby a trade deficit gets worse (for instance, bigger) before it gets better (for instance, smaller) following a devaluation of the currency.

Macroeconomics

Macroeconomics is concerned with issues, objectives and policies that affect the whole economy. All economic analysis that refers to aggregates is macro. The UK unemployment rate, the UK inflation rate, the rate of economic growth in the UK; these are all UK aggregates and therefore macro issues.

Marshall Lerner condition

This condition states that for a devaluation to be successful in terms of reducing atrade deficit, the sum of the elasticity of demand for UK exports and the elasticity of demand for UK imports must be greater than one.

Monetary policy

This is government policy concerned with the money supply, the rate of interest and the exchange rate. At any one time, the government can only really try to control one of these three things. Whilst it is quite easy to set the base rate, some would argue that it is futile to try and control the money supply (see the early 80s) and attempts to control the exchange rate (for example, within the ERM) can also lead to disaster. Monetary policy in the UK is now, sensibly, centred on the adjusting of the interest rate (the job of the MPC) with the goal of controlling the inflation rate.

Monetary Policy Committee

Four days after the election of the Labour government in May 1997, the Chancellor, Gordon Brown, announced that decisions on whether interest rates should change would be transferred to the independent Monetary Policy Committee (MPC) of the Bank of England. The nine members of the committee meet once a month and announce their decision at midday on the first Thursday of each month.

National debt

This is the total amount of money owed by the government. It is the sum of all the PSNCRs ever accumulated. The UK government currently owes about £400 billion!

New Deal

This has been one of the major policies of the Labour government. Put simply, it guarantees either training or a job to all young people. It has been so successful that the government is planning to extend the scheme to all those who are long-term unemployed, regardless of age.

Nominal exchange rate

These are the 'normal' measures of exchange rates. The daily exchange rate for the £/$, and the £/euro are both nominal exchange rates.

Official reserves

This is the section of the capital account that deals with movements of government reserves of gold and foreign currencies. The government may use these reserves to influence the value of the pound. Since the UK fell out of the ERM the government has tended not to intervene in the currency markets, allowing the pound to find its own level.

Perfectly inelastic demand

If a good has perfectly inelastic demand, then its demand curve is vertical, implying that the demand for the good in question will remain unchanged regardless of the size of the price change.

Portfolio investment

This refers to movements of money between countries for the buying and selling of shares and bonds. It is one of the main sections in the capital account. If a UK resident bought shares in an American company, this would appear as an outflow of money in this section (-). If an American bought some shares in a British company, this would appear as an inflow of money in this section (+).

Price elasticity of demand

It measures the responsiveness of the quantity demanded to a given price change. It can be calculated by dividing the percentage change in the quantity demanded of a good by the percentage change in its price.

Public Sector Net Cash Requirement (PSNCR)

This is the amount of money that the government has to borrow each year. It is, therefore, the difference between tax revenues and total government spending for a given year. If a government manages to spend less than it collects in tax revenue then it can use what it has left to pay off some of the national debt. In this situation, the PSNCR is negative, or it is called a Public Sector Debt Repayment (PSDR). The PSNCR used to be called the Public Sector Borrowing Requirement (PSBR).

Purchasing Power Parity (PPP)

This is a 'parity' or exchange rate based on the 'purchasing powers' of the two countries in question. If a given basket of goods cost £20 in the UK and the same basket costs $40 in the USA, then the exchange rate based on the price levels, and therefore the purchasing powers, of each country will be £1 = $2.

Real exchange rate

This is the same as the effective exchange rate except an allowance is made for changes in the price level in the UK and the rest of the world. Even if the effective exchange rate remains constant, if UK inflation is higher than world inflation over a given period of time, then the real exchange rate will rise, making UK exports less competitive.

Retail Price Index (RPI)

This is an index measuring the average change in the price level of a basket of goods and services. The average is weighted to reflect the relative importance of the various goods and services. The RPI is published every month and is then used to calculate the annual percentage change in the average price level (or inflation rate).

Revaluation

This is the term used for a large rise in the value of a currency, usually when it is realigned within a fixed exchange rate system, as opposed to a appreciation, which is a gradual rise in the value of a currency in a floating exchange rate system.

Single European Act

This is the Act that was signed by all EU members in 1985. It committed all EU countries to the adoption of a single market in the EU with no barriers to trade, movement of labour or capital.

Stability pact

This is the pact entered into by countries in euro-land whereby they promise to keep their annual budget deficit within 3% of their GDP.

Trade deficit

This is the deficit in the 'trade in goods' part of the current account of the balance of payments (i.e. the value of imports of goods are higher than the value of exports of goods). This should not be confused with the budget deficit, which is a short phrase used to describe the PSNCR (i.e. any government spending over and above government tax revenue, for a given year).

Trade in goods

This is the section of the current account that measures the value of goods that are exported and imported. It includes any tangible items, such as oil, food, raw materials, consumer goods, etc.

Trade surplus

This is the surplus in the 'trade in goods' part of the current account of the balance of payments (i.e. the value of exports of goods are higher than the value of imports of goods).

Trade weighted index

This is an index series that gives the weighted average of the pound's exchange rate with the main world currencies. The weights are based on the amount of trade done in each currency, so the majority of the weighting is devoted to the euro. This is why the trend of the trade weighted index tends to follow the £/euro nominal exchange rate.