When the Central Bank uses expansionary monetary policy, the money supply increases whilst the interest rates fall. This is because when money is readily available in the economy due to monetary expansion, the interest rates will fall due to the fact that people will be more willing to make loans as oppose to taking out loans. Reduced interest rates will cause domestic financial and capital assets to become less attractive as a result of their lower real rates of return. In addition to this, foreigners will reduce their position in domestic bonds, real estate, stocks and other assets. The financial account with deteriorate as a result of foreigners holding fewer domestic assets.
If the Federal rate goes up, there will be less spending which ... ... middle of paper ... ...ll have some immediate consequences on the economy, but I believe that these will even out in the short term as our country begins to get back on its feet. A budget that reduces spending will enable us to begin to pay back some of our national debt, which will increase the value of our currency in the world markets. This will in turn give more buying power for our dollar, reducing inflation, and increasing the likelihood of more investing. As you can see, everything starts at the top. If the federal government will straighten themselves out, the rest of the country will follow along.
The Federal Discount Rate is an interest rate, so lowering it is essentially lowering interest rates. If the Federal Bank instead decides to lower reserve requirements, this will cause Banks to have an increase in the amount of money they can invest. This causes the price of investments such as bonds to rise, so interest rates must fall. No matter what tool the Fed uses to expand the money s... ... middle of paper ... ...lly and fewer domestic goods sold abroad, the balance of trade falls. As well, higher interest rates cause the cost of financing capital projects to be more, so capital investment will be less.
Inflation can lead to unemployment, as people demand less due to higher prices and therefore demand for labor maybe decreased. Inflation also creates uncertainty for entrepreneurs, cost curves increase and revenue can decrease thus squeezing profits. Also when inflation is in the mind of the entrepreneur it can escalate easily as they will take inflationary actions like automatically increase prices and therefore it is imperative government spending/borrowing is controlled. Although government borrowing does increase the money supply, the monetarist view of a direct link between money supply and inflation is wrong, as proved when Britain experienced recession under Margaret Thatcher. In order to control the money supply the government cut borrowing and spending, which in theory would reduce the money supply, inflation and unemployment but interest rates had to rise to stop consumer borrowing, which in turn increased the exchange rate.
3) Changing the discount rate. This article talks about the Fed decreasing the discount rate to stimulate the economy. The discount rate is the rate of interest the Fed charges for loans it makes to banks. An increase in the discount or interest rates makes it more expensive for banks to borrow from the Fed. A discount rate decrease makes it less expensive for banks to borrow.
From nominal and real rates there are also lowered and raised rates. When the interest rate is lowered consumer spending grows while savings decrease. Spending on items such as housing becomes one of the ways the AD rises. Though AD rises it pulls the economy out lack of spending, but puts the economy into the possibility of inflation. Differentiating from low rates, high rates stop inflation but creates the possibility of recession.
Lower taxes will increase consumers spending because they have more disposable income. This will worsen the govt budget deficit. The other method is Deflationary fiscal policy this involves decreasing AD therefore the government will cut their spending and or increase taxes. Higher taxes will reduce consumer spending. This will lead to an improvement in the government’s budget deficit.
Wealth is drained from the economy for unproductive purposes and economic growth slows down as there are fewer funds for infrastructural development. Also, employment creation for a high percentage of unemployed population becomes challenging. Circular flow of income is the lifeline of a flourishing economy. Unemployment slows down this flow by the lack of money inflow and outflow. When money is not pumping into the economy, its growth becomes sluggish.
The examples of expansionary monetary policy are reduction in reserves, decrease in overall discount rates and purchase of government securities. These are the tools which are used by central banks during recession period. This practice requires the incresse of flow of money in markets thus decreasing the overall interest rates and borrowing costs. When the interest rates are high the central bank promotes the lowering the discount rates. As the interest rates falls the consumer and investor can borrow money more easily and cheaply.
Following the decrease in the price of a good, there is an increase in the quantity demanded by the consumer due to the substitution effect. However, in such a case, the income effect is opposite (Krugman and Wells