Direct and indirect effects could happen as the money supply increases; the direct effect being that people will demand more goods and services and the indirect effect being that people will save more money, depositing this in banks (Monetary Policy, n.d.). Therefore, excess reserves will also increase and the banks will be able to lend out more. Banks will motivate borrowing by lowering interest rates and this will increase the demand for investment and consumption and therefore aggregate demand will increase. Businesses respond to increased sales by producing more, thus increasing production. An increase in production would require more labor, thus lowering unemployment, and raises the demand for capital goods.
It is the rate at which depository institutions borrow and lend from one another in the federal funds market. The FOMC’s open market operations lower the rate by increasing the reserves supplied to the economy, or alternatively, raise the rate by reducing the supply of balances. Due to a term structure of interest rates, the changes in the short-term interest rates are transmitted to the long-term interest rates since the financial markets expect the changes to persist for an extended period of time or assume that they convey information about the future monetary policy. Also, the inflation inertia ensures that the change in the federal funds rate effectively influences the real interest rate which is equivalent of the cost of borrowing. By altering the cost, federal funds rate indirectly affects the spending and investment by households and businesses, which on their turn, impact output and inflation in the economy.
ROLE OF MONEY IN MACROECONOMICS 1. Introduction Money can be seen as the medium of exchange which is acceptable while transaction is being undertaken between two parties. Some of the common forms of money are: - Commodity money: This is when the value of the good represents its value in terms of money like gold or silver. - Fiat money: This is when the value of the good is less than the value it represents - Bank money: It is the accounting credits that can be used by the depositor Money serves a variety of crucial functions in the economy and this is why it has gained an unparalleled influence in the matters of economy at micro as well as macro levels. Some of the features of money that make it so important for any economy are as follows:
Influence of inflation on growth velocity of the money explained due to the fact that buyers increase their purchases in order to protect themselves from the economic losses owing to the decrease in purchasing power of money. The coefficient of monetization The important indicator of status of money supply step forth the coefficient of monetization that is equal to: C=M2/GDP The coefficient of monetization permits to answer if there is enough money in circulation. It shows how much GDP provided with money (or how much money is there for $ GDP). In developed countries this coefficient come to 0,6 or even close to
Also, it refers to the general price level increase because of increasing of consumer which is manifested in consumer price index (CPI). CPI is used by the consuming public to recognize how their purchasing power is getting effected. It aims to compare the cost of purchasing the market basket bought by a typical consumer during a specific period with the cost of purchasing the same market basket during earlier period. (Gwartney, James D.; Stroup, Richard L.; Sobel, Russell S. 1999) Due to real factors, the demand-Pulled Inflation will occurred by issues such as: fall in tax rates, without change in government spending, increase in investments, increase in government spending without change in tax revenue, decrease in savings, increase in exports, and/ or decrease in imports. For instance, buyers started generating more income or more volume of money, thus there will be high demand and the price of the goods or services will be increased.
Business Cycle is the movement of GDP in the long term. It is usually a mixture of upward and downward movement. A change in total demand can cause the IS curve to change whereas a change in demand / supply of money would cause the LM curve to shift. When talking about IS/LM we should also know about the liquidity trap. The Liquidity Trap is a situation in which an injection of money by
Along these lines, unemployment may decrease, as this has different favorable circumstances, for example, lower government using on profits and less social issues. However, this phenomenon includes a number of different expenses. Firstly, if economic growth is unsustainable and is higher than the long run pattern rate, inflations are liable to be seen. An increase in economic growth could prompt an equalization of issued installments. In case the expanded customer expenditure causes further development, there will be an increase in the import sector.
Activity I: a. the bank 's specific cash market risk is dependent on the increase in the interest rate because the interest rate in the futures market is a function of the interest rate in the cash market. It is calculated as follows: Cash Market Risk = 10000000 * 0.0461*(90/365) = $113,671.23 To hedge against the borrowing costs, the bank should sell Eurodollar futures because the futures interest rate is up trending. By doing so, any increase in the cash market interest rate would be matched in the futures market interest rate to offset any gain or loss on the scheduled issue of Eurodollar futures b. The best futures contract for the bank to use is June 2009 because it has the higher interest rate of 5.38%. The profit on the futures trade is calculated as follows: Profit =
Cost-push inflation happens when we face higher prices due to the increase in cost of production and higher costs of raw materials. It is determined by supply side factors. Cost-push inflation can be caused by higher price of commodities, imported inflation, higher wages, higher taxes and higher food prices (Economics Help, 2011). Demand-pull inflation happens when there is an increase in the price of goods and services when demand increases too much that it outpaces supply (US Economy, 2015). Sometimes people refer it as “too much money chasing too few goods”.
The multiplier effect refers to the fact that when the government increases its spendings, firms and households receive that spending and re-spend that income (government spending is received as income). This leads to multiple routes of spending, so overall the increase in net aggregate demand is greater than the initial increase in government spending. Therefore, a small increase in government spending can possibly be enough to stimulate the economy, because the net increase in AD will be greater. Secondly, another advantages is effects on the supply-side. In this case, the spending is mainly on improving infrastructure and livelihoods, meaning there are supply-side effects, which increases the short run aggregate supply.
If interest rates increase, it will become attractive to invest money in that country because investors will get a higher return from savings in that country’s banks. Therefore the currency demand will rise. But higher interest rates will have a negative impact on the country. This is due to the reduction in purchasing power of the consumer while the loan borrowers have to pay more interest. Foreign investors are attracted towards a country that has a strong economy.
Monetary policy is a term used to refer to the actions of central banks to achieve macroeconomic policy objectives such as price stability, full employment, and stable economic growth. The Federal Reserve controls over the federal fund rates give it the ability to influence the general level of short-term market interest rates. The Fed has three main tools at its disposal to influence monetary policy which are the open-market operations, discount rate, and reserve requirements. b. Monetary policy is the actions of a central bank, currency board or other regulatory committee that determine the size and rate of the money supply, which in turn affects interest rates.