2.8 - the role of money and financial markets

• money


  anything that is generally accepted as a means of payment for a good or service
• medium of exchange


  anything that sets the standards of goods and services, acceptable to all parties involved in a transaction
• financial sector


  consist of financial organisations and their products and involves the flow of capital
• investment


  The purchase of goods that are used to produce future goods and services
• rate of interest (interest rate)


  The cost of borrowing money and the reward for saving money
• building society


  A mutual financial institution that is owned by its members. Its primary objectives are to receive deposits from its members and to lend money to members for property.
• mortgage


  an agreement with a financial institution to borrow money to purchase a property
• Insurance company


  Financial institution that guarantees compensation for specified loss, damage, illness or death in return or an agreed premium
• debit cards


  take money directly from your current account and transfer it to the seller. If you do not have enough money in your account, you cannot buy the product

  there is no charge to the seller for accepting these cards in payment
• credit cards


  enable you to buy goods whether or not you have the money in your account i.e a loan up to 30 days. If you cannot pay it all back, you are charged interest on the amount outstanding.

  retailers are charged for allowing you to use these cards in payment
• role of the central bank BOE

  to issue bank notes. In England and Wales, only the Bank of England can do this.

  to control monetary policy by setting the bank rate, which is the interest rate set by the Bank of England from which all other interest rates are calculated

  to provide financial stability by trying to ensure that the UK’s citizens can trust financial organisations

  to manage the country’s foreign reserves

  to act as the bank for the commercial banks
• role of commercial banks

  to take deposits (savings) from customers and turn them into assets for the banks. They do this by investing, or lending the money that customers deposit, thus gaining a higher rate of interest than that which they are paying on the deposits.
• the financial sector enables individuals and firms to use their savings productively. It also provides an efficient payment system that reduces the costs and risks of producing goods and services and of purchasing them. It does this by allowing consumers, producers and the government to overcome economic uncertainties associated with imbalances between income and expenditure
• savings


  the part of a person’s (disposable) income which is not spent on consumption. Savings are done by savers
• basic rule to a rise in interest rates offered to savers 


  basic rule to a rise in interest rates offered to savers will encourage people to increase their levels of savings. Equally a fall in interest rates available to savers will result in people reducing their level of savings
• borrowing


  to receive money from another party with the agreement that the money will be repaid
• what do higher interest rates do to the cost of borrowing


  higher interest rates increase the cost of borrowing. This higher cost means that both individuals and firms tend to borrow less. This is because not only is new borrowing more expensive, but also people are having to pay more on money they have already borrowed
• how do interest rates affect the level of investment


  the level of investment is inversely related to the rate of interest. This means that if the rate of interest falls, the level of investment should increase

  a fall in the rate of interest means not only that the cost of borrowing has gone down, so it is cheaper to borrow for investment, but also that there is a lower opportunity cost involved in sacrificing saving.

  Lower interest rates will encourage consumers to spend and therefore firms will want to expand in order to meet this expected rise in demand