In the short-run, the relationship between unemployment and inflation is inverse. This means that the change in one will have the opposite effect on the other. So here, a fiscal policy aimed at reducing unemployment will increase the interest rate. For example, if Bartavia decides to lower taxes to increase consumption thru use of consumer’s marginal propensity to consume, and the economy in general thru the multiplier effect, it will increase the aggregate demand for goods and services. Marginal propensity to consume is the idea that that consumers will spend more money if they have more, but increases in income do not lead to equal increases in consumption because people save some of the money.
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.
The Federal Reserve and Macroeconomic Factors Introduction The Federal Reserve controls the economy of the United States through a variety of tools. They use these tools to shape the monetary policy of the United States in order to promote economic growth and reduce the rate of inflation and the unemployment rate. By adjusting these tools, the Fed is able to control the amount of money in the supply. By controlling the amount of money, the Fed can affect the macro-economic indicators and steer the economy away from runaway inflation or a recession. The Federal Reserve The Federal Reserve uses three main tools in order to control the money supply.
With interest rates, this allows banks to take a percentage of the consumer’s money and loan it out to others, thus allowing economic growth to be possible. Interest rates also allow lenders to have a “safety net” which is necessary because there is a possibility that the borrower would be unable to pay back a loan to the bank. A nation’s interest rates can be raised or lowered and these shifts in interest rates correlate directly to aggregate demand. Aggregate demand, is the total demand for final goods and services in an economy at a given time (Business Dictionary). A nation uses interest rates for economic growth or to help prevent inflation.
Monetary policy is controlled by the Central Bank and influences money supply . Fiscal policy uses changes in taxes and government spending to affect overall spending and stabilize the economy. When lowering taxes the people have more to spend then the government decreases spending and the economy slows down therefore the economy stabilizes. The objective of fiscal policy is the governments’ typical use fiscal policy to promote strong and sustainable growth and reduce poverty. During periods of recession congress has the option to decrease taxes to give households more disposable income so they can buy more products.
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.
This will decrease the money supply because banks are not able to lend out as much money to customers. Conversely, if the required ratio decreases banks are required to hold a lesser amount of money in reserve therefore increasing the money supply because banks can lend out mo... ... middle of paper ... ...up. Inflation and GDP are directly related to each other however, a strategic combination of the macroeconomic tools could allow the Fed to control inflation with out affecting GDP, if it is within acceptable limits. When inflation is too high the economy is at risk of crashing because the value of currency is too low. Conclusion Unemployment is inversely related to changes in GDP.
Monetary policy is usually classified one of two ways, expansionary policy and contractionary policy. The goal of expansionary policy is increasing the total supply of money rapidly. The goal of contractionary policy is to increase total money supply slowly or shrink the total money supply. While expansionary policies are aimed to help unemployment, contractionary policy is aimed to stop deterioration of the values of assets. Monetary policy is used by the Federal Reserve also known as the “Fed”.
Keynesianism also calls for the government to spend more to try to help the economy grow. Keynesianism was a short-term solution to the problem and could only do so much for the economy before inflation caught up with it, and took it into recession. On the other hand we have supply side economics, which works on more of a long-term basis. It basically attempts to stimulate economic growth, which would reduce inflation, and raise the standard of living. Supply side proponents say that by reducing government regulations and taxation, this will stimulate more economic growth, and market equilibrium will be reached on it’s own, without government impositions.
America needs to stop being frivolous with its money because spending is not going to help it get out this huge deficit that it has put itself in. The first thing America needs to do is use the impending inflation to its advantage. Usually inflation would be viewed as a bad thing but, this inflation will “raise the prices of a great many commodities, goods and services, among which would be the price of housing” (Mulligan 3). This would be a good thing because it would help mortgages rise which in turn would result in the reduction of foreclosures. Foreclosures are the first sign of economic decline so, a decrease in the amount of foreclosure would demonstrate that a restoration is occurring within the economic turmoil.