The Effects of Monetary Policy on Macroeconomics, GDP, Unemployment, Inflation and Interest Rates

The Effects of Monetary Policy on Macroeconomics, GDP, Unemployment, Inflation and Interest Rates

Length: 1607 words (4.6 double-spaced pages)

Rating: Excellent

Open Document

Essay Preview

More ↓
Introduction
Economics primarily focuses on how laws and government policies impact the economy. Much of this looks at taxes specifically and more generally the public finance, which includes the spending and borrowing the government does. The root word of economics is economy. Economy comes from the Greek oikos - home and nomos - managing. (Dkosopedia, 2006) Economy can be described as the current soundness of financial indicators such as jobs and job growth, economic productivity and output, and can also be measured by a vast range of other factors such as the trade deficit, national debt, GDP, and unemployment rates. In this paper, the effects of the monetary policy on macroeconomics, GDP, unemployment, inflation and interest rates will be discussed. Throughout the paper explanations of how money is created will be given along with discussing what monetary policies combination will achieve the goal of economic growth, low inflation, and a reasonable rate of unemployment, what combination of monetary policies will better accomplish this goal.
Monetary policy goals
One goal of the Federal Reserve, commonly known as the Fed, is to affect the economic production and employment, both of which depend on many other factors. They are influenced by monetary policy; when demand weakens, the fed lowers interest rates, which in turn stimulates the economy, by allowing the consumer to spend more and the industry to produce thus job retention is good. In contrast, continuous stimulus to increase salary or if demands falls, productivity will decrease, jobs are lost and this will push the economy's inflation higher. The Fed just tries to smooth out the bumps of natural business cycle. Inflation is an economy wide rise in prices which is bad because it makes it hard to tell if a business product price is going up because of higher demand or inflation. Inflation also adds premium to long-term interest rates. Much debate encircles whether zero inflation is a target. Some economist says that when inflation is low, interest rates are low so the fed does not have much room to boost the economy if it is necessary. When inflation is close to zero there is more risk of deflation. Deflation occurs when there is a nation wide fall in prices. On the surface, this may sound optimal for the consumer but this is just as bad as inflation. A prolonged deflation, like the great depression, can lead to significant declines in home and business values.

How to Cite this Page

MLA Citation:
"The Effects of Monetary Policy on Macroeconomics, GDP, Unemployment, Inflation and Interest Rates." 123HelpMe.com. 17 Feb 2019
    <https://www.123helpme.com/view.asp?id=166011>.

Need Writing Help?

Get feedback on grammar, clarity, concision and logic instantly.

Check your paper »

Macroeconomic Objectives And Objectives Of Macroeconomics Objectives Essay

- The economy tend to move from boom to recession, it is difficult for government to maintain and achieve macroeconomics objectives. At this time, there are “conflicts between government macroeconomic objectives”, which is this extended essay main theme. This essay will look at the government macroeconomic objectives, the conflicts between macroeconomics objectives, the best policy or mixture of policies to minimize the conflicts between macroeconomics objectives and recommendations, which are classified as main objectives and additional objectives....   [tags: Inflation, Monetary policy, Macroeconomics]

Research Papers
1754 words (5 pages)

Macroeconomics Focuses On The Economy Essay

- ... The sharp reduction in those periods reflected a marked downgrade in the economic outlook and the increased downside risks to both output and inflation (Rich, 2013). Furthermore, most homeowners in the United States primarily owned housing assets that were highly leveraged. Meaning if someone had a mortgage of $80,000 on a $100,000 home and the value of the home drops 20 percent, now as a homeowner they are losing money because their home is now worth $80,000 (Mian & Sufi, n.d.). Now they are balanced out basically losing 100 percent because no profits are being made....   [tags: Inflation, Macroeconomics, Monetary policy]

Research Papers
737 words (2.1 pages)

Impact of Macroeconomics on the Housing Industry Essay

- To better understand the real impact macroeconomics has in an economy or a particular industry, it is better to define what macroeconomics is and what it attempts to study. Contrary from microeconomics which studies the impact that individuals or companies have in a local economy, macroeconomics focuses on the behavior of the economy or industries as a whole, in a national or global perspective. (Investopedia.com, 2015) However, microeconomics and macroeconomics are interdependent and complement each other....   [tags: Macroeconomics Essay]

Research Papers
612 words (1.7 pages)

Essay about Determinants Of Inflation On Australia

- Determinants of Inflation in Australia Abstract: The objective of this study is to examine the determinants of inflation in Australia using the time series data from 1995 to 2015. The Multiple Linear Regression method has been used to explain the relationships between the dependent variable - Inflation and the three independent variables – Real Money Supply M3, Real GDP and Real imports. The empirical results show that money supply and GDP have significant impact on inflation and have a negative relationship with inflation in Australia, while real imports positively but not significantly affect inflation....   [tags: Inflation, Economics, Macroeconomics, Money supply]

Research Papers
1491 words (4.3 pages)

Long Run Equilibrium, The Values Of Inflation And The Supply Shocks Are At Their Mean Values

- At long-run equilibrium, the values of inflation and both demand and supply shocks are at their mean values (π_t=π_(t-1),ε_t=v_t=0) Hence long-run equilibrium inflation, π_t=π_(t-1)=π* = 3% From Adaptive expectation, we have 〖 E〗_t (π_(t+1) )=E_(t-1) (π_t), substituting into Phillips curve, we obtained the long-run equilibrium output, Yt = Y ̅_t = 100. Given Monetary policy rule i_t=π_t+ρ+θ_π*(π_t-π_t^* )+θ_Y*(Y_t-Y ̅_t ) and the fact that at long-run equilibrium, inflation is at its target and output equals natural output, we get long-run equilibrium nominal interest rates i_t=π_t+ρ=3+4=7%; from Fisher equation and Adaptive expectation, we get the real long-run interest rate of r_t=i_t-π_t=...   [tags: Inflation, Supply and demand, Macroeconomics]

Research Papers
1046 words (3 pages)

Macroeconomics : A Market Cycle Essay

- ... (Boettke) The Austrian economics have a different view on the boom and bust. First, they stated that the boom begins with low federal funds interest rates. (Boom and Bust Cycle) Therefore, the boom gets started with an expansion of credit from low interest rates. Moreover, with the credit generated, Austrians believe that people start investing in projects like housing construction. Once, the bust occurs, investors began to break even or even lose money since rates and circumstances has change....   [tags: Inflation, Unemployment, Business cycle]

Research Papers
706 words (2 pages)

The Monetary Policy Of The United States Essay

- ... Frank Southard’s work includes finance and development and his main findings include development of the economic system and the effects of policy on society (Southard). Additionally, Alberto Alesina and Lawrence H. Summers writes in Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence. Their studies illustrate the performance of macroeconomics and independence within the central bank. They found that more independent central banks are associated with lower levels of inflation....   [tags: Central bank, Monetary policy, Money supply]

Research Papers
996 words (2.8 pages)

The Macroeconomic Environment Is A Dynamic Environment Essay

- Question 1 The macroeconomic environment is a dynamic environment, which could not remain unchanged (Gajewsky 2015). There are many factors influence the global macroeconomic environment, such as interest rate, exchange rate, GDP,aggregate demand, monetary policy and other macroeconomic variable (Oxelheim and Wihlborg 2008). These factors are closely associated with commodity price. For commodity price, the demand and supply are directly contributing to the price volatility. The changes in interest rates and exchange rates are significant influence for commodity output and it also has impact on the commodity prices (Dornbusch 1976)....   [tags: Inflation, Monetary policy, Macroeconomics]

Research Papers
1224 words (3.5 pages)

Money Supply and Inflation Essay

- Money Supply plays an important role in macroeconomic analysis, especially in selecting an appropriate monetary and fiscal policy. Considerably, I am yet to come across theoretical work that has been done on this topic (analysis money supply and its impact on other variable i.e. inflation, interest rate, real GDP and nominal GDP). However some other topics similar to this one have been done by AL-SHARKAS, Adel, where he uses the same technique and models on the topic ‘out put response to shocks to interest rate, inflation and stock returns....   [tags: Economy, Macroeconomics]

Research Papers
1726 words (4.9 pages)

Monetary Policy Impact On Macroeconomics Essay

- There are 12 Federal Reserve Banks that make up the central bank in the United States of America. These 12 banks are also known as the Fed. The Fed has three tools of monetary policy they can use to control the money supply. They are open-market operations, the reserve ratio, and the discount rate. These three tools used by the Fed have an impact on gross domestic, product (GDP), inflation, interest rates, and unemployment. Open-Market Operations The Fed's the most important tool is the open-market operations....   [tags: Economics Finance Economy]

Research Papers
1496 words (4.3 pages)

With low prices come low interest rates, and less room for the fed to stimulate the economy. The main goal is to keep the economy steady, achieve neutrality. An utopian economical society looking for the perfect blend of policies to create a solid economy.
Monetary policy tools
The feds influence the market mainly by raising or lowering interest rate called the "federal funds". Banks are required to keep a certain amount of money in reserves to pay for overnight checks, stock ATMs, and other payments. When a bank is running low on reserves it may borrow some from a bank with too many reserves. The interest rates on these loans adjust to supply and demand. If the fed wants to raise or lower the rates, it buys or sells securities from banks, in which the bank receives or sells in reserves. They do this until the banks have too many reserves and must loan them out, so the interest rate lowers, or the banks do not have enough reserves and must borrow, causing interest rates to rise. The fed also pays attention to foreign markets. When the dollar is too low, the feds buy out dollars (with foreign currency) to cushion the pressure.
How is money created?
Most money does not exist in tangible form. In fact, less than 10%t of U.S. money is in the form of bills or coins. Over 90% exists only as electronic data stored in a computer. For example, Mr. X has some money. Although he may have some cash, most of his money exists in bank accounts or brokerage accounts, and his wealth is stored as data in various computer systems.
There are two ways in which new money can be created. First, it can be printed as bills or manufactured as coins. More frequently, however; money is created just by changing the data stored in a computer. For instance, if his bank was to credit his checking account with, say, a million dollars, all that would happen is that they would make a new entry in their computer. As soon as they made this entry, he would have a million dollars to his name. No new bills or coins would need to be created. (Colander, 2004)
Although it is unlikely that Mr. X's bank is going to credit his account with a million dollars out of the goodness of their heart, the scenario described is similar to the way in which most of the money in the economy is actually created.
When money is put in the bank, the bank does not keep all the money in a vault (or even in a computer). They loan most of it out to other people. That is how banks make a profit: they accept a deposit from one person, and loan the money to another person. The profit comes from loaning the money out at a higher rate of interest than what they pay for it. For example, a bank might pay Mr. X 4% interest on his savings account, but loan the same money out to another customer at 12% interest, 18% interest if the credit is less than favorable.
The Federal Reserve, which regulates banking, does not let banks loan out all their deposits. By law, banks must retain a certain amount of money on reserve, called the reserve rate. In most cases, the reserve rate is 10%. In other words, banks are allowed to loan out 90% of the money that they accept for deposit. Here is an example to show how it works.
Let's say he deposits $10,000 into his bank account. The bank keeps $1,000 (10%) on reserve, and loans $9,000 (90%), to someone else. That person then uses the $9,000 to buy something, and the money ends up being deposited in another bank, so on and so forth.
This is a simple account on how money is made even more important, the Federal Reserve is charged with the job of regulating U.S. banks. By making sure that the banks are run correctly, the Federal Reserve inspires continuing faith in the system.
During the 1929-1933 recessions, the Fed was much younger and was not nearly as effective as it is now. In retrospect, economists now believe that if the Fed had done a better job maintaining an adequate money supply during the first crucial years, the Depression would have been significantly shorter and a great deal milder. (James, 1997)
Balancing employment, inflation, and economic growth
When discussing employment, understanding that it is the single most important indicator of an economy. Employment is definitely a frequently used platform for many politicians. Unemployment is a problem which requires immediate attention, but so is under employment. In other words, those jobs which pay low and do not offer much in employee benefits can also be detrimental to the economy.
Often when laying off employees, the stock market shows approval of this and the company's value raises, even though labor loss means there is loss of productive capacity. The measure for the market is the productive capacity per dollar and the market reacts in many cases to this theory.
Inflation is defined as a general reduction in the purchasing power of money. One of its causes may be an increase in money supply relative to the supply of goods and services in the marketplace. A topic discussed earlier in the how money is created section.
Interest rates are what lenders charge for the use of their money for a specified period. Part of this interest charge is profit and insurance to cover the cost of the lender not being repaid by the consumer.
Interest rates and inflation can become the cause of why money may be worthless, the value of the dollar diminished. This is far off, but may occur with the large deficit held under the current administration. Low interest rates are believed to encourage economic growth; however, high interest rates are believed to restrain inflation. So how will there ever be a balance?
Conclusion
The monetary policy was created in order to manage the amount of money in the economy. (The Times, 2006) In contrast, measuring the amount of money in the economy was not always a good guide to inflation and demand. Interest rates are set to ensure that economical demands are consistent with the certain level of inflation. Finding an even ground with the tools provided by the monetary policy alone, was not feasible. A combination of the monetary policy with banking supervision may seem to be a better mix.

References

Clarida, Richard H. and Jordi Galli, "The Science of Monetary Policy: A Keynisian

Perspective", Journal of Economic Literature Vol XXXVII, December 1999.
Financial Times. 1990. Title of article. Financial Times (June 11), pp. 14-22.
No author listed.
James, Claudette, "Understanding Macroeconomics", Vol I, October 1997.
Lazear, Edward P. 1986. Salaries and piece rates. Journal of Business 59, no. 3:405-31.
McConnel &Bruce (2005). Economics, principles, problems, and policies. Chapter 15

(16th ed). New York: McGraw-Hill.

Wikipedia, the free encyclopedia, http://en.wikipedia.org/, retrieved on 3 December

2006.
Return to 123HelpMe.com