Eduqas A Level Economics Financial Stability Exam Questions

About Eduqas A Level Economics Financial Stability

Financial stability is part of the policy instruments section of the Eduqas specification and reflects the lessons of the 2007 to 2008 financial crisis. You need to understand the growth in size and influence of the UK financial sector, how asset bubbles form and why they burst, and why financial regulation is needed to protect the wider economy. You must also evaluate whether a large financial sector is good for the real economy. Detailed knowledge of the UK regulatory system is not required, so focus on the economic arguments. This topic links to monetary policy, QE, the balance of payments (financial services exports) and the national debt.

What you need to know

• The UK financial sector The UK has one of the largest financial sectors in the world relative to GDP, centred on the City of London. It provides banking, insurance, fund management and foreign exchange services and contributes a large share of tax revenue and service exports.
• Role of banks Banks take deposits and lend, transferring funds from savers to borrowers. They create credit, and their lending supports consumption and investment in the real economy.
• Asset bubbles A bubble forms when asset prices (houses, shares) rise far above their underlying value, driven by easy credit, speculation and overconfidence. When the bubble bursts, falling prices destroy wealth, reduce lending and cut AD.
• The 2007 to 2008 crisis Risky mortgage lending and complex securities spread losses across the global banking system. Banks faced liquidity and solvency problems, lending collapsed and governments had to bail out banks, increasing national debt and leading to a deep recession.
• Need for regulation Regulation aims to prevent excessive risk taking, for example by requiring banks to hold more capital and liquid assets, and to deal with moral hazard when banks expect to be rescued.
• Does a large financial sector help the real economy? It brings jobs, tax revenue and exports, and channels funds to investment. However, it can make the economy vulnerable to shocks, divert talent from other sectors and increase inequality.

Common mistakes in Financial Stability

• Describing an asset bubble as any rise in house prices. A bubble is a rise well above underlying value, driven by speculation and credit, that is unsustainable.
• Writing detailed descriptions of UK regulators. Eduqas states detailed knowledge of the regulatory system is not required; explain the economic reasons for regulation.
• Ignoring moral hazard. If banks believe they will be bailed out, they have an incentive to take excessive risks.
• Presenting the financial sector as only harmful. Balance the risks with its contribution to output, jobs, tax and service exports.

Try three Financial Stability exam-style questions