Safe
harbour
Protection
from the rough seas of regulation. Laws and regulations often include a safe
harbour clause that sets out the circumstances in which otherwise regulated
firms or individuals can do something without regulatory oversight or
interference.
Satisficing
Settling
for what is good enough, rather than the best that is possible. This may occur
in any situation in which decision makers are trying to pursue more than one
goal at a time. Classical economics and neo-classical economics assume that individuals,
firms and governments try to achieve the optimum, best possible outcome from
their decisions. Satisficing assumes they decide for each goal a level of
achievement that would be good enough and try to find a way to achieve all of
these sub-optimal goals at once. This approach to decision making is
commonplace in behavioural economics. It can be regarded as a realist's theory
of how decisions are taken. The concept was invented by Herbert Simon
(1916-2001), a Nobel prize-winning economist, in his book, models of man, in
1957.
Savings
Any
income that is not spent. Ultimately, savings are the source of investment in
an economy, although domestic savings may be supplemented by capital from
foreign savers or themselves be invested abroad.
In
an economic sense, savings include purchases of shares or other financial
securities. However, many official measures of a country's savings ratio--total
savings expressed as a percentage of total income--leave out such financial
transactions. At times when the demand for financial securities is unusually
high, this can give a misleading impression of how much saving is taking place.
How
much individuals save varies significantly among different age groups (see
life-cycle hypothesis) and nationalities. Everywhere, people of all ages save
more as their income rises. The supply of savings rises when interest rates
rise; a rise in interest rates causes demand for funds to invest to fall; a
rise in demand for investment funds may cause interest rates, and thus the cost
of capital, to rise. The level of savings is also influenced by changes in
wealth (see wealth effect) and by taxation policies.
Say's
law
Supply
creates its own demand. So argued a French economist, Jean-Baptiste say
(1767-1832), and many classical and neo-classical economists since. Keynes
argued against say, making the case for the use of fiscal policy to boost
demand if there is not enough of it to produce full employment.
Scalability
The
ease with which the supply of an economic product or process can be expanded to
meet increased demand. Recent technological advances have led some economists
to talk about the growing importance of instant scalability. For example, once
a piece of software has been written it can be made available in an instant
over the internet to unlimited numbers of users for almost no cost. This
potentially allows a new product to enter and win market share far more quickly
than ever before, intensifying competition and perhaps accelerating the process
of creative destruction.
Scarcity
Supplies
of the factors of production are not unlimited. This is why choices have to be
made about how best to use them, which is where economics comes in. Market
forces operating through the price mechanism usually offer the most efficient
way to allocate scarce resources, with government planning playing at most a
minor role. Scarcity does not imply poverty. In economic terms, it means simply
that needs and wants exceed the resources available to meet them, which is as
common in rich countries as in poor ones.
Scenario
analysis
Testing
your plans against various possible scenarios to see what might happen should
things not go as you hope. Scenario analysis is an important technique in risk
management, helping firms and especially financial institutions to ensure that
they do not take on too much risk. Its usefulness does of course depend on risk
managers coming up with the right scenarios.
SDR
Short
for special drawing rights. Created in 1967, the SDR is the IMF's own currency.
Its value is based on a portfolio of widely used currencies.
Search
costs
The
cost of finding what you want. The economic cost of buying something is not
simply the price you pay. Finding what you want and ensuring that it is
competitively priced can be expensive, be it the financial cost of physically
getting to a marketplace or the opportunity cost of time spent fact-finding.
Search costs mean that people often take decisions without all the relevant
information, which can result in inefficiency. Technological changes such as
the internet may sharply reduce search costs, and thus lead to more efficient
decision making.
Seasonally
adjusted
There
are seasonal patterns in many economic activities; for instance, there is less
construction in winter than in summer, and spending in shops soars as Christmas
approaches. To reveal underlying trends, statistics reflecting only part of the
year are often adjusted to iron out seasonal variations.
Second-best
theory
As
we do not live in a perfect world, how useful is economic theories based on the
assumption that we do? Second-best theory, set out in 1956 by Richard Lipsey
and Kelvin Lancaster (1924-99), looks at what happens when the assumptions of
an economic model are not fully met. They found that in situations where not
all the conditions are met, the second-best situation - that is, meeting as
many of the other conditions as possible - may not result in the optimum
solution. Indeed, reckoned Lipsey and Lancaster, in general, when one optimal
equilibrium condition is not satisfied all of the other equilibrium conditions will
change.
Potentially,
the second-best equilibrium may be worse than a new equilibrium brought about
by government intervention, either to restore equilibrium to the market that is
in disequilibrium, or to move the other markets away from their second-best
conditions.
Economists
have seized on this insight to justify all sorts of interventions in the
economy, ranging from taxing certain goods and subsidizing others to restricting
free trade. Whenever there is market failure, second-best theory says it is
always possible to design a government policy that would increase economic
welfare. Alas, the history of government intervention suggests that although
the second best may be improved on in theory, in practice second best is often
least worst.
Secondary
market
A
market in second-hand financial instruments. Bonds and shares are first sold in
the primary market, for instance, through an initial public offering. After
that, their new owners often sell them in the secondary market. The existence
of liquid secondary markets can encourage people to buy in the primary market,
as they know they are likely to be able to sell easily should they wish.
Securities
Financial
contracts, such as bonds, shares or derivatives that grant the owner a stake in
an asset. Such securities account for most of what is traded in the financial
markets.
Securitisation
Turning
a future cash flow into tradable, bond-like securities. Creating such
asset-backed securities became a lucrative business for financial firms during
the 1990s, as they invented new securities based on cash flow ranging from
future mortgage and credit-card payments to bank loans, movie revenue and even
the royalties on songs by David bowie (so-called bowie-bonds). Securitisation
has many benefits, at least intheory. Issuers gain instant access to money for
which they would otherwise have to wait months or years, and they can shed some
of the risk that their expected revenue will not materialize. By selling
securitised loans, investment banks are able to finance their customers without
tying up large amounts of capital. Investors can hold a new sort of asset, less
risky than unsecured bonds, giving them the risk-reducing benefit of
diversification. But there are dangers. The future cash flow underlying the
securities may flow earlier or later than promised, or not at all.
Seignorage
Traditionally,
the profit rulers made from allowing metals to be turned into coins. Now it
refers in a loosely defined way to the power of a country whose notes and coins
are held by another country as a reserve currency.
Seller's
market
A
market in which the seller seems to have the upper hand and so can charge a
higher price than in a buyer's market.
Seniority
The
order in which creditors are entitled to be repaid. In the event of a
bankruptcy, senior debt must be paid off before junior debt. Because junior
debt has a lower chance of being repaid than senior debt, it carries more risk,
and thus typically pays a higher yield.
Sequencing
Shorthand
for implementing economic reforms in the right order. In recent years, this has
become a hot topic in development economics. Some economists argue that
introducing the right policies alone is not enough to revive a malfunctioning
economy; reforms must be implemented in the right sequence. Thus they debate
when in the reform process there should be, say, privatisation of state
enterprises, and in which order, or the lifting of capital controls or other
trade barriers. Other economists dispute whether there is a right sequence.
Services
Products
of economic activity that you can’t drop on your foot, ranging from
hairdressing to websites. In most countries, the share of economic activity
accounted for by services rose steadily during the 20th century at the expense
of agriculture and manufacturing. More than two-thirds of output in OECD countries,
and up to four-fifths of employment, is now in the services sector.
Shadow
price
The
true economic price of an activity: the opportunity cost. Shadow prices can be
calculated for those goods and services that do not have a market price,
perhaps because they are set by government. Shadow pricing is often used in
cost-benefit analysis, where the whole purpose of the analysis is to capture
all the variables involved in a decision, not merely those for which market
prices exist.
Shareholder
value
Putting
shareholders first; the notion that all business activity should aim to
maximise the total value of a company’s shares. Some critics argue that
concentrating on shareholder value will be harmful to a company’s other
stakeholders, such as employees, suppliers and customers.
Shares
Financial
securities, each granting part ownership of a company. In return for risking
their capital by giving it to the company’s management to develop the business,
shareholders get the right to a slice of whatever is left of the firm’s revenue
after it has met all its other obligations. This money is paid as a dividend,
although most companies retain some of their residual revenue for investment
purposes. Shareholders have voting rights, including the right to vote in the
election of the company’s board of directors. Shares are also known as
equities. They can be traded in the public financial markets or held as private
equity.
Sharpe
ratio
A
rough guide to whether the rewards from an investment justify the risk,
invented by bill Sharpe, a winner of the Nobel Prize for economics and
co-creator of the capital asset pricing model. You simply divide the past
return on the investment (less the risk-free rate) by its standard deviation,
the simplest measure of risk. The higher the Sharpe ratio is the better, that
is, the greater is the return per unit of risk. However, as it is a
backward-looking measure, based on what an investment has done in the past, the
Sharpe ratio does not guarantee similar performance in future.
Short-termism
Doing
things that make you better off in the short-run but worse off in the end.
After the bursting of the stock market bubble and the failure of Enron at the
start of the 2000s, much like during the 1980s, accusations of short-termism
were often made against the stock market-focused capitalism of the united
states and the UK. During the bubble, it was claimed, investors had become too
focused on short-term profits and changes in share prices, and failed to probe
deeply enough into long-term performance. As a result, managers did things that
made their profits look as good as possible in the short run, often to the
detriment of their company's long-term health. Indeed, many firms engaged in
misleading and even fraudulent accounting practices to inflate short-term
profits. In the 1980s and early 1990s, the complaint took a slightly different
form, and was arguably less convincing, namely that short-termism caused lower
levels of investment by businesses than in countries where the stock market was
less important, such as Germany and Japan.
Shorting
Selling
a security, such as a share, that you do not currently own, in the expectation
that its price will fall by the time the security has to be delivered to its
new owner. If the price does fall, you can buy the security at the lower price,
deliver it to whoever you sold it to and make a profit. The risk is that the
price rises, leaving you with a loss.
Signalling
A
solution to one of the biggest sources of market failure: asymmetric
information. Often the biggest problem facing sellers is how to convince buyers
that what they are selling is as good as they say it is. This problem arises in
situations where the qualities of the thing being sold cannot be observed
easily by buyers, who thus fear that sellers may be conning them. In such
situations, an answer may be for sellers to do something that shows they mean
what they say about quality. This something is what economists call signalling.
Going
to a leading university might be worth far more for what it signals to
prospective employers about your abilities than for what you learn as a student.
Likewise, the fact that a firm is willing to spend a lot of money advertising
its product may say far more about what it thinks of the product than any
information included in the actual ad To be useful, signals must impose more
costs on those who use them to send false messages than any gains to be had
from lying.
Simple
interest
Interest
calculated only on the initial amount borrowed or invested. Contrast with
compound interest.
Social
benefits/costs
The
overall impact of an economic activity on the welfare of society. Social
benefits/costs are the sum of private benefits/costs arising from the activity
and any externalities.
Social
capital
The
amount of community spirit or trust that an economy has gluing it together. The
more social capital there is, the more productive the economy will be. Yet,
curiously, one of the best-known books to address the role of social capital,
"bowling alone", by Robert Putnam of Harvard university, pointed out
that Americans were far less likely to be members of community organizations,
clubs or associations in the 1990s than they were in the 1950s. He illustrated
his thesis by charting the decline of bowling leagues. Yet the American economy
has gone from strength to strength. This has led some economists to question
whether social capital is really as important as the theory suggests, and
others to argue that membership of bowling leagues and other community organizations
is simply not a good indicator of the amount of social capital in a country.
Social
market
The
name given to the economic arrangements devised in Germany after the second
world war. This blended market capitalism, strong labour protection and union
influence, and a generous welfare state. The phrase has also been used to
describe attempts to make capitalism more caring, and to the use of market
mechanisms to increase the efficiency of the social functions of the state,
such as the education system or prisons. More broadly, it refers to the study
of the different social institutions underpinning every market economy.
Socialism
The
exact meaning of socialism is much debated, but in theory it includes some
collective ownership of the means of production and a strong emphasis on
equality, of some sort.
Soft
currency
A
currency that is expected to drop in value relative to other currencies.
Soft
dollars
The
value of research services that brokerage companies provide “free” to investment
managers in exchange for the investment managers’ business. Economists disagree
on whether or not such hidden payments are economically inefficient.
Soft
loan
A
loan provided at below the market interest rate. Soft loans are used by
international agencies to encourage economic activity in developing countries
and to support non-commercial activities.
Sovereign
risk
The
risk that a government will default on its debt or on a loan guaranteed by it.
Speculation
An
attitude to investment that is often criticized. According to critics,
speculation involves buying or selling a financial asset with the aim of making
a quick profit. This is contrasted with long-term investment, in which an asset
is retained despite short-term fluctuations in its value. Speculators actually
play a valuable role in financial markets as their appetite for frequent buying
and selling provides liquidity to the markets. This benefits longer-term
investors, too, as it enables them to get a good price when they do eventually
sell.
Spot
price
The
price quoted for a transaction that is to be made on the spot that is, paid for
now for delivery now. Contrast spot markets with forward contracts and futures
markets, where payment and/or delivery will be made at some future date. Also
contrast with long-term contracts, in which a price is agreed for repeated
transactions over an extended time period and which may not involve immediate
payment in full.
Spread
The
difference between one item and another. A much used term in financial markets.
Examples are the differences between:
The
bid (what a dealer will pay) and ask or offer (what a dealer will sell for)
price of a share or other security;
The
price an underwriter pays for an issue of bonds from a company and the price
the underwriter charges the public;
The
yield on two different bonds.
Stabilisation
Government
policies intended to smooth the economic cycle, expanding demand when
unemployment is high and reducing it when inflation threatens to increase.
Doing this by fine tuning has mostly proved harder than Keynesian policymakers
expected, and it has become unfashionable. However, the use of automatic
stabilisers remains widespread. For instance, social handouts from the state
usually increase during tough times, and taxes increase (fiscal drag), boosting
government revenue, when the economy is growing.
Stability
and Growth Pact
Budgetary
rules agreed to by Euro Zone countries as a condition of joining the euro. The
pact stipulates that all the countries will run a balanced budget in normal
times. A government that runs a fiscal deficit bigger than 3% of GDP must take
swift corrective action. And if any country breaches the 3% limit for more than
three years in a row, it becomes liable to fines of billions of Euros. The pact
was supposed to be a powerful political symbol that euro-using countries would
not cheat each other. However, Portugal became the first country to break the
deficit limit by notching up 4.1% in 2001. When, in 2002, France and Germany
also exceeded the 3% limit, some EU members were outraged and others lobbied
for the pact to be modified or even scrapped.
Stagflation
Term
coined in the 1970s for the twin economic problems of stagnation and rising
inflation. Until then, these two economic blights had not appeared
simultaneously. Indeed, policymakers believed the message of the Phillips
curve: that unemployment and inflation were alternatives.
Stagnation
A
prolonged recession, but not as severe as a depression.
Stakeholders
All
the parties that have an interest, financial or otherwise, in a company,
including shareholders, creditors, bondholders, employees, customers,
management, the community and government. How these different interests should
be catered for, and what to do when they conflict, is much debated. In
particular, there is growing disagreement between those who argue that companies
should be run primarily in the interests of their shareholders, in order to maximize
shareholder value, and those who argue that the wishes of shareholders should
sometimes be traded off against those of other stakeholders.
Standard
deviation
A
measure of how far a variable moves over time away from its average (mean)
value.
Standard
error
A
measure of the possible error in a statistical estimate.
Statistical
significance
There
are lies, damned lies and statistics, said Benjamin Disraeli, a British prime
minister. Certainly, even if the result of number crunching is statistically
significant, it does not actually mean it is true. But it does mean it is much
more likely to be true than false. Statistical significance means that the probability
of getting that result by chance is low. The most commonly used measure of
statistical significance is that there must be a 95% chance that the result is
right and only a 1 in 20 chance of the result occurring randomly.
Sterilised
intervention
When
a government or central bank buys or sells some of its reserves of foreign
currency this can affect the country’s money supply. Selling reserves decreases
the supply of the domestic currency; buying reserves increases the domestic
money supply. Governments or central banks can sterilise (that is, cancel out)
this effect of foreign exchange intervention on the money supply by buying or
selling an equivalent amount of securities. For example, if the government
increases reserves by buying foreign currency the domestic money supply will
increase, unless it sells securities such as treasury bills to mop up the extra
demand.
Sticky
prices
Petrol-pump
prices do not change every time the oil price changes, and holiday prices and
standard hotel rates are fixed for months. Sticky prices are slow to change in
response to changes in supply or demand. As a result there is, at least
temporarily, disequilibrium in the market. The causes of stickiness include
menu costs, inadequate information, consumers' dislike of frequent price
changes and long-term contracts with fixed prices. Prices change only when the
cost of leaving them unchanged exceeds the expense of adjusting them. In
financial markets, prices move all the time because the cost of quoting the
wrong price can be huge. In other industries, the penalty may be much less
severe. Small disequilibria in, say, the pricing of hotel rooms will not make
much difference. So hotel prices are often sticky.
Stochastic
process
A
process that exhibits random behaviour. For instance, Brownian motion, which is
often used to describe changes in share prices in an efficient market (the
random walk), is a stochastic process.
Stocks
Another
term for shares. What are called ordinary shares in the UK is known as common
stock in the United States. It is also another word for inventories of goods
held by a firm to meet future demand.
Stress-testing
A
process for exploring how a portfolio of assets and/or liabilities would fare
in extreme adverse conditions. A useful tool in risk management.
Structural
adjustment
A
programme of policies designed to change the structure of an economy. Usually,
the term refers to adjustment towards a market economy, under a programme
approved by the IMF and/or World Bank, which often supply structural adjustment
funds to ease the pain of transition. Such policies are much criticised in the
developing world, sometimes with good reason.
Structural
unemployment
The
hardest sort of unemployment to cure because it is caused by the structure of
an economy rather than by changes in the economic cycle. Contrast with cyclical
unemployment, which can, in theory if not always in practice, be cut without
sparking inflation by stimulating faster economic growth. Structural
unemployment can be reduced only by changing the economic structures causing
it, for instance, by removing rules that limit labour market flexibility.
Subsidy
Money
paid, usually by government, to keep prices below what they would be in a free
market, or to keep alive businesses that would otherwise go bust, or to make
activities happen that otherwise would not take place. Subsidies can be a form
of protectionism by making domestic goods and services artificially competitive
against imports. By distorting markets, they can impose large economic costs.
Substitute
goods
Goods
for which an increase (or fall) in demand for one leads to a fall (or increase)
in demand for the other – coca-cola and Pepsi, perhaps.
Substitution
effect
When
the price of petrol falls people buy more of it. There are two reasons.
The
income effect: cheaper petrol means that real purchasing power rises, so
consumers have more to spend on everything, including petrol.
The
substitution effect: petrol has become cheaper relative to everything else, so
people switch some of their consumption out of goods that are now relatively
more expensive and buy more petrol instead.
Sunk
costs
When
what is done cannot be undone. Sunk costs are costs that have been incurred and
cannot be reversed, for example, spending on advertising or researching a
product idea. They can be a barrier to entry. If potential entrants would have
to incur similar costs, which would not be recoverable if the entry failed,
they may be scared off.
Supply
One
of the two words economists use most, along with demand. These are the twin
driving forces of the market economy. Supply is the amount of a good or service
available at any particular price. The law of supply is that, other things
remaining the same, the quantity supplied will increase as the price increases.
The actual amount supplied will be determined, ultimately, by what the market
price is, which depends on the amount demanded as well as what suppliers are
willing to produce. What suppliers are willing to supply depends on several
things:
The
cost of the factors of production;
Technology;
The
price of other goods and services (which, if high enough, might tempt the
supplier to switch production to those products); and
The
ability of the supplier accurately to forecast demand and plan production to
make the most of the opportunity.
Supply
curve
A
graph of the relationship between the price of a good and the amount supplied
at different prices.
Supply-side
policies
Increasing
economic growth by making markets work more efficiently. In the 1980s, Ronald Reagan
and Margaret Thatcher championed supply-side policies as they attacked Keynesian
demand management. Pumping up demand without making markets work better would
simply lead to higher inflation; economic growth would increase only when
markets were able to operate more freely. Thus they pursued policies of
deregulation, liberalization and privatization and encouraged free trade. To
reduce unemployment, they tried to increase the efficiency of the jobs market
by cutting the rate of income tax and attacking legal and other impediments to
labour market flexibility. The results of these programmes are much debated. In
particular, the belief, apparently supported by the Laffer curve, that cutting
tax rates would increase tax revenue did not always stand up well to real-world
testing. Even so, it is now recognised that supply-side reforms are a crucial
element in an effective economic policy.
Sustainable
growth
A
term much used by environmentalists, meaning economic growth that can continue
in the long term without non-renewable resources being used up or pollution
becoming intolerable. Mainstream economists use the term, too, to describe a
rate of growth that an economy can sustain indefinitely without causing a rise
in inflation.
Systematic
risk
The
risk that remains after diversification, also known as market risk or
undiversifiable risk. It is systematic risk that determines the return earned
on a well-diversified portfolio of assets.
Systemic
risk
The
risk of damage being done to the health of the financial system as a whole. A
constant concern of bank regulators is that the collapse of a single bank could
bring down the entire financial system. This is why regulators often organise a
rescue when a bank gets into financial difficulties. However, the expectation
of such a rescue may create a moral hazard, encouraging banks to behave in ways
that increase systemic risk. Another concern of regulators is that the risk
management methods used by banks are so similar that they may increase systemic
risk by creating a tendency for crowd behaviour. In particular, problems in one
market may cause banks in general to liquidate positions in other markets,
causing a vicious cycle of liquidity being withdrawn from the financial system
as everybody rushes for the emergency exit at once.
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