These fluctuations in economic activity usually have implications on employment, consumption, business confidence, investment and output. Theories and the nature and causes of business cycle fluctuations The Keynesian Approach This theory shows how the collaboration of multiplier and accelerator can lead to regular cycles in aggregate demand. The Keynesians believe that economic activity is generally unstable and is subject to inconsistent shocks, usually causing the economic fluctuations and are attributed to the changes in autonomous expenditures especially investment. The Keynesian approach is pretty simple; higher investment will lead to a larger rise in income and output in the short run. This means that consumers will spend some of their income on consumption goods.
The issue concerning money equilibrium affects the internal and external balances of trade (Columbus, 2004). Exchange rate refers to the price of a currency in relation to another. In the floating exchange rate these prices are determined by the foreign market which fluctuates occasionally. The floating exchange rates have a great impact on a country’s economy and this might trigger its stability or instability. There is an automatic adjustment in case a country has a larger payment deficit which leads to continuous currency outflow from the country.
The commercial banks will have negative reserves in assets and negative checkable deposits in liabilities and net worth. Commercial banks and the public are willing to buy or sell government bonds to the Fed depending on the price of bonds and their interest ... ... middle of paper ... ... are made throughout simulation to increase money and decrease money in the system to control the monetary policies. The simulation shows how controlling the money supply has an impact on the economy. Creating the right balance between GDP and inflation is critical for the economy. Conclusion The Fed uses easy money policy to increase the money supply when real GDP is low and unemployment is high; however, the Fed must keep a watch on inflation because GDP and inflation tends to work in the same direction.
Monetary policy reposes on the relationship between the rates of interest in an economy and the total dispense of money. Monetary policy uses a diversity of tools to dominate exchange rates with other currencies and unemployment. This is done in order to influence outcomes like economic growth and inflation. A policy is called contractionary if it diminishes the size of the money supply or increases the interest rate. An expansionary policy raises the size of the money supply, or lowers the interest rate.
Under a managed float regime, the foreign exchange rate is determined by demand and supply forces in the market but the central bank intervenes when their domestic currency grow too weak or strong. Under unsterilized foreign exchange intervention, the central bank influences the foreign exchange rate by adjusting MB to instigate changes in MS. Increasing MS by buying international reserves induces depreciation of domestic currency whereas decreasing MS by selling international reserves induces appreciation of domestic currency by influencing both nominal domestic interest rate and expectation about future exchange rate. Central banks also engage in a sterilized foreign exchange interventions “when they offset the purchase or sale of international reserves with a domestic sale or purchase. For example, the purchase of $10000 million of international currency by central bank might be sterilized by selling $10000 million worth of domestic government bonds. When engaging in sterilized intervention, there is no net change in MB, therefore long-term effect does not exist on the exchange rate.
This makes exchange rates an extremely important monetary tool. However, the exchange rate itself is in fact influenced by a number of factors. 3.1.1 Bank Rate The Reserve bank of India achieves its monetary policy objectives by changing the bank rate. When such a change comes unexpected, the market changes its expectations about the future monetary policy. Therefore an increase in the bank rate, indicating a tight monetary policy, would result in expectations that the bank rate will decrease in the future.
Interest rates, inflation, and exchange rates are highly correlated; interest rates have been used by Central banks to exert influence over exchange rate and inflation as a fiscal policy, high interest rates attract foreign capital and tries to rise the exchange rate, on the other hand this impact could be mitigated by the high inflation differential between countries (Bergen, 2010, para. 5). As a general rule, A fall in the interest rate will lead to a fall in the value of the currency against other currencies, if Country A interest rate declines, then more investors in that country will withdraw their money from the banks in order to invest them in the U.S., therefore, the funds transferred to the U.S. would pressure Country A’s currency to lose value (Aashwin, 2005). Moreover, Country A interest decrease will encourage the demand of U.S. currency while the supply of Country A’s currency will rise, thus, Country A’s currency will depreciate or worth less in terms of the U.S. dollar. Similarly, Country A’s investor might find viable to exchange Country A’s currency for Country’s B currency as a bridge to finally make a conversion to U.S. dollars.
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.
More specifically, fiscal policy has a significant effect on inflation in countries where government securities markets are less developed. In this connection, Telatar, Telatar and Ratti (2003) argue that term structure contains important information about future inflation and therefore can be used as a guide for initiating monetary policy to target price stability. According to their study, short-term borrowing at high interest rate stimulates re-borrowing in order to repay the debt services, thereby creating a viscous circle of high budget deficits and high interest rates. Since political weakness is one of the major reasons to this chronic and high budget deficit and inflation, the development of stable political institutions is therefore necessary in order to stabilize prices.
First I would like to discuss the Monetary Policy and how it applies to inflation and deflation. Monetary Policy is the regulation of the money supply and interest rates by a central bank, such as the Federal Reserve Board in the U.S., in order to control inflation and stabilize currency. Monetary policy is one the two ways the government can impact the economy. By impacting the effective cost of money, the Federal Reserve can affect the amount of money that is spent by consumers and businesses (WebFinance, Inc, 2011). Wages and prices will begin to rise at faster rates if monetary policy motivates aggregate demand enough to shove labor and capital markets beyond their long-run capacities.