The Financial Services Industry

Closed Economy Model

Basic Components

In a closed economy, we have two primary entities:

  1. Households (Consumers): They provide factors of production like land, labor, and capital (sometimes including enterprise/entrepreneurship).

  2. Firms (Producers): They produce goods and services.

Circular Flow of Wealth

  • Households provide factors of production to firms.

  • Firms, in turn, generate profits, wages, and rents that flow back to households.

  • Firms produce products (output).

  • Households spend money on these products.

Fiscal Policy

Definition

Fiscal policy refers to government policies related to taxation and expenditure.

Government Role

The government implements fiscal policy through:

  • Spending: An injection into the circular flow.

  • Taxation: A leakage from the circular flow.

Public Sector Net Cash Requirement (PSNCR)

  • Typically, governments spend more than they collect in taxes.

  • The shortfall is the PSNCR.

  • PSNCR=GovernmentExpenditure−TaxationPSNCR = Government Expenditure - Taxation

  • This shortfall is financed through instruments like treasury bills or gilts.

Monetary Policy

Central Bank's Role

  • In the UK, monetary policy is managed by the Bank of England (BoE), the central bank.

  • The BoE sets interest rates to meet an inflation target set by the government (e.g., 2% CPI).

  • This activity determines the cost of money.

Banks

  • When banks make investments, it's an injection into the circular flow.

  • Savings put into banks represent a leakage because it's money taken out of the system.

Balance of Payments

International Flow of Money

The balance of payments reflects the flow of money between the UK and the rest of the world.

  • Exports: Represent injections because they bring in foreign currency.

  • Imports: Represent leakages because they send money abroad.

Economic Equilibrium

Injections and Leakages

For an economy to be in equilibrium, total injections must equal total leakages.

GovernmentExpenditure+Exports+Investments=Taxation+Imports+SavingsGovernment Expenditure + Exports + Investments = Taxation + Imports + Savings or G+X+I=T+M+SG + X + I = T + M + S

Where:

  • G = Government Expenditure

  • X = Exports

  • I = Investments

  • T = Taxation

  • M = Imports

  • S = Savings

Fisher Equation

Concept

The Fisher equation explains the relationship between money supply, velocity of money, price levels, and transactions in an economy.

Equation

M<br>eqV=P<br>eqTM <br>eq V = P <br>eq T

Where:

  • M = Money Supply

  • V = Velocity of Circulation of Money

  • P = General Level of Prices

  • T = Number of Transactions

The equation suggests that, in the short term, V and T are relatively fixed, while M and P are variables that tend to increase together.

Globalization and Global Trends

International Markets

Events in international markets affect asset prices in the UK market.

  • Multinational companies operate and have assets across multiple markets.

  • They can move their taxable domicile globally.

  • Global operations are common.

  • Foreign currency fluctuations impact the domestic economy.

Definition of Globalization

Globalization is the interconnected nature of business and finance.

Organizations Promoting Globalization

  • WTO (World Trade Organization)

  • OECD (Organization for Economic Cooperation and Development): Aims to support sustained economic growth.

Impact of Technology

Advancements in technology and lowered costs have facilitated outsourcing to lower-cost centers.

Effects of Globalization

Globalization can adversely affect some populations while benefiting poorer populations through increased economic opportunities.