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.
Lewis views these danger as justified, however, if the purpose of creating new money is to create new capital to invest; the consequential inflation will be “self-destructive” and may even lead to lower prices (79). By investing the newly created money, production and output increase. Creating capital, therefore, leads to higher input and investment that subsequently increases output and lowers prices. While inflation through creating money temporarily lowers other’s incomes, it increases profit and output until equilibrium is reached (78). Thus, a smaller capital-output ratio, or the production time relative to the initial investment, is preferred to avoid panic and price rises.
Zero inflation may help the market to avoid imbalances, stabilize the business cycle, and promote steady growth in our economy. On the other hand, zero inflation may not reduce unemployment. It may not promote a higher rate of saving and investment, and it may increase income inequality by redistributing income to the high-income people from the low-income people. The topic of a zero inflation rate is an especially interesting dilemma at the moment because monetary policy and interest rates remain at center stage of the economic policy debate. During the last recession, the question was how fast and how low the Federal Reserve should lower interest rates.
The IS/LM model stands for Investment Saving / Liquidity preference. In case where the nominal money supply is increased by the Central bank for any uses that will shift the LM curve to the right, this will cause a lowering of interest rate and a rising of Gross Domestic Product. In case where the Central bank wants to raise interest rate, than it has of course to decrease the money supply and shift the LM curve to the left and this will cause a fall of national income. In other words if the Central banks decides to raise the interest rate, consumers aren’t willing to take any credits that’s why the GDP, in which contains disposable income plus Investment plus government spending, will go down and the whole economy will be effected. To explain the IS curve in a better way, we take the example of the government, if the government decides to spend more on government spending and cut taxes for lower salary earners, than consumers ... ... middle of paper ... ...not in the short-run, that why FED lets the economy to boost when there is inflation in the short term.
The additional income allows people to spend more causing more demand. Businesses may respond to this rising demand by raising prices because they know they cannot produce enough. In order to stop inflation, the central bank uses a restrictive monetary policy. This is where interest rates are raised and the bank sells its holdings of treasures and other bonds. The reduction in the money supply restricts liquidity and slows down economic growth.
Although government spending has the potential to stimulate the economy, this essay will explain why the opposite outcome is more likely to result in the short-term. It will be shown, by analyzing the flow of money and the economies of certain countries, that government spending has little economic benefit and does not create new jobs. Nonetheless, in the right circumstances, government spending can prove beneficial to the long-term economic growth of a country. Before the government can spend any money, it must first acquire that money. A government’s two options is either to increase taxes or to redistribute money from within, from one department to another.
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.
The Keynesian theory of unemployment emphasizes the argument that if monetary and fiscal policy does not keep demand at a high enough level, then the economy is less likely to be able to sustain a high rate of employment. A growing economy creates jobs for people entering the labour market for the first time. And, it provides employment opportunities for people unemployed and looking for work. However, not every increase in aggregate demand and production has to be met by employing more labour. Businesses may decide to increase production by making greater use of capital inputs such as extra units of
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.
I can see the Federal Reserves reasoning behind raising interest rates to slow down the economy and lower inflation, but they need to realize that the rate of inflation is not completely dependant upon the rise and fall of the economies well-being. The past has proven to us numerous times that the economy is quite capable of being stable and prosperous without effecting the inflation rate in a negative way. That’s why I feel that it would be in the nations best interest to continue letting the economy expand into bigger and better things without raising interest rates to unneeded proportions. WORKS CITED Forbes, Steve. “Bad Idea Begets Bad Economy.” Forbes.