OCR Economics F585 June 2012

How do asset prices get affected by interest rates? If the interest rate goes down, does it mean that mortgage repayments and share values fall?

Also could someone improve this answer: I'm unsure if its right/sufficient or not:

Define and explain monetary and fiscal policy credibility (4)

Monetary policy credibility is the assurance of economic agents such as firms and consumers in a financial authority like the BoE in maintaining the money supply and inflation within a given level through base interest ratte changes; it is also analysed by foreign firms wishing to invest in the given country as it indicates stability and thus determines confidence domestically and externally to an economy. Fiscal policy credibility is the confidence of firms, workers, consumers and lenders in the capacity of a government to equilibrate or balance their budget; for example, firms see fiscal policy as credible when they believe their taxes will be maintained at a level as a government can successfully maintain government spending without increasing taxes, adversely affecting firms. It also determines the cost of borrowing because if a government can attain tax revenue at a level similar to spending, lenders will believe they will get a sufficient or entire return on their initial lent amount of money and thus they are perceived and often given a respectable e.g. AAA credit rating.

How do asset prices get affected by interest rates? If the interest rate goes down, does it mean that mortgage repayments and share values fall?

Changes in the official rate also affect the market value of securities, such as bonds and equities. The price of bonds is inversely related to the long-term interest rate, so a rise in long-term interest rates lowers bond prices, and vice versa for a fall in long rates. If other things are equal (especially inflation expectations), higher interest rates also lower other securities prices, such as equities. This is because expected future returns are discounted by a larger factor, so the present value of any given future income stream falls. Other things may not be equal—for example, policy changes may have indirect effects on expectations or confidence—but these are considered separately below.

How do asset prices get affected by interest rates? If the interest rate goes down, does it mean that mortgage repayments and share values fall?

Also could someone improve this answer: I'm unsure if its right/sufficient or not:

Define and explain monetary and fiscal policy credibility (4)

Monetary policy credibility is the assurance of economic agents such as firms and consumers in a financial authority like the BoE in maintaining the money supply and inflation within a given level through base interest ratte changes; it is also analysed by foreign firms wishing to invest in the given country as it indicates stability and thus determines confidence domestically and externally to an economy. Fiscal policy credibility is the confidence of firms, workers, consumers and lenders in the capacity of a government to equilibrate or balance their budget; for example, firms see fiscal policy as credible when they believe their taxes will be maintained at a level as a government can successfully maintain government spending without increasing taxes, adversely affecting firms. It also determines the cost of borrowing because if a government can attain tax revenue at a level similar to spending, lenders will believe they will get a sufficient or entire return on their initial lent amount of money and thus they are perceived and often given a respectable e.g. AAA credit rating.

Can someone explain the Isew and ppp please?

ISEW is basically an index to measure sustainable economic development. They adjust the real GDP value for expenditure that improves well being or reduces it. For example increase expenditure on defense would increase the level of GDP however peoples quality of life has not actually improved it has just merely been restored. So ISEW builds on the limitations that just using real gdp to measure growth. So what the Isew aims to do is takeaway from real GDP things that reduces well being like environmental degradation,defensive expenditure and loss of natural stock of capital. Then add to real gdp things that increase well-being for example non-defensive expenditure, capital spending (investment) domestic labour(unpaid housework). It is thought this gives a real picture to see if the growth achieved is sustainable and benefiting the people.

PPP- the exchange rate that equalises the price of a basket of identical traded goods and services in two different countries. PPP aims to measure the true value of a currency in terms of the goods and services it will buy. This is taken from the green ocr book so learn that definition. However to gain full marks they don't want you to just regurgitate a definition, you also need to explain why it is useful, For example it allows for int'l comparisons. This was a previously asked question in a past paper so look up the mark scheme for it- it should help.

PPP- the exchange rate that equalises the price of a basket of identical traded goods and services in two different countries. PPP aims to measure the true value of a currency in terms of the goods and services it will buy.

hey,

If there is a fixed exchange rate, does changes in aggregate demand effect the exchange rate?

I thought the real exchange rate does this. Havent they confused this with actual PPP? Because PPP is an equilibration of the cost of living with a given basket of goods on the going nominal ER; thus the PPP does show the value of the currency in it's good purchasing power, but only when two countries have the same purchasing power?

Their definition seems odd because the PPP is a situation where 2 currencies integrate to have equal purchasing power; it isnt ever used to show general analyses of the relative real purchasing power between 2 countries UNLESS they have equal purchasing power - correct?



'This was a previously asked question in a past paper so look up the mark scheme for it- it should help.'Which year?

How can you relate the J-Curve to the information in Extract 2? (i.e. China's exchange rate system etc)

Almost all centres predict questions to be honest, so it's all pretty much betting . A wide synoptic revision would be sufficient to answer most of the questions (probably?) on this exam...I think :P

Having said your point earlier about extract 4 coming up alot for last question, a girl I know said that global in January this year was very generalised and not that specific to the extract. I am not sure.

I think a lot of this exam is based on your exam skills, in terms of answering the questions set. And having a strong ability to evaluate is essential.

The APT and Tutor2u book both have diagrams on Extract 4 that show supply of Chinese rare earths to the rest of the world shifting to the left and becoming vertical. This I understand, as currently the Chinese have a quota on rare earths.

Except, the title of the extract 'Emerging dispute over China's rare earths export ban', and in the last paragraph 'it would ban the export of certain rare earths from 2015'. So surely we'd somehow need to comment on the fact that Chinese rare earths won't just decrease in the qty. supplied - but some of those rare earths may not be supplied at all?

I haven't seen any evaluation on it anywhere and I'm just feeling like I'm misinterpreting?

If you want I can type the mark scheme answer on here if you want.