The General Theory of Employment, Interest, and Money - Research Proposal Example

RESEARCH PROPOSAL, MACRO & MICRO ECONOMICS; RESEARCH METHODS IN ECONOMICS (INCOME DETERMINATION) Literature Review The functions and operations of the bank have over the years researched to establish the relationships of the various variables that are in operation. The paper look into bank and household income and how it is affected by endogenous and exogenous variables. Moreover, the determination of factors affecting banking income help management in strategizing ways to increase revenue collection as well how to minimize costs of running business. The literature review discusses peer-reviewed paper that shows how other people have endeavored in the subject. Mitroi and Oproiu took a study to find out the correlation between consumption loans and the income of the citizens. The presumed that the consumptions of loans increased significantly as the monthly income of the citizen increased.1 On the conduction the regression analysis, Mitroi and Oproiu found that the relationship between loan consumption and personal income had an R2 value of 0.89. However, the statistical significant value was considered while holding another factor constant because e the Durbin- Watson test revealed a significant value of 0.13. The value is too low to signify that there are other factors that influences consumption of loans other than population income.2 Bank earn their income through lending of its customers savings. Therefore, the management of loan portfolio is important for bank to manage their income. To this end, bank do have a measure of smoothening the customer loans in case they are unable to honor their pledge to pay the loan in full plus interest rate.3 Managers of the bank, therefore, manage to maintain their income earning by minimizing the risk perception, observe regulatory constraints while at the time handle compensation and agency problem arising from consumption and developments loans.4 According to Young and Rice, the source of banking income have changed in the past decade as a result of the advent in research, technology, market situations and divergence business strategies.5 In 1980 to 2001, the U.S. commercial banks had an increase of noninterest income from 20% t0 42% of the overall operation of the banking industry.6 Although little has been done on the influence of noninterest income on financial performance, there have been varying incomes across banks. However, according to Young and Rice, the noninterest income have endeared major banks by selling products such as mortgages and credit cards.7 The data of bank income today shows that noninterest income comprises the largest share of commercial bank than it was in 1984.8 The phenomenon does not affect the U.S. market only, but it is a scenario reported by all developed economies from 1982 to 1990. However, the increase in the noninterest income increases more rapidly in large banks compared to smaller banks.9 Therefore, the traditional source of income for the bank is being replace by interest of emerging market. The banking industry has faced stringent regulation, strategies, and technology innovation in the recent past due to financial impropriety among the players in the industry. The result of impropriety affected the developed country a lot of financial loss as a result of bursting of market bubbles.10 The deregulation and technology advanced competition among financial markets, bank and nonbanks institution. As a result of increased competitions and threat of decreased income, the industry resulted to noninterest income to enable them remain in the market. Nevertheless, some bank have remained with the old production strategies and have rendered them noncompetitive in the industry. The abolition of the restriction on interest rates assured bank to use market rates to charge for credit advanced to its customers. Moreover, bank abandoned severe charges on customer’s deposits and substituted it with a ‘bundle’ of products such as travelers check, checks and safety deposits boxes.11 Moreover, the enactment of Riegle-Neal Act of 1994, allowed bank to expand their market beyond the borders of the U.S.12 Traditionally bankers argued that reliance on noninterest income would lead to income volatility and thus it was a dangerous adventure to engage. However, this has been proven wrong because banks products are subject to diversification and thus they will always remain relevant even in the long run. In addition, increased involvement of the bank in noninterest income has decreased the risk attached to loans. 13Therefore, noninterest income has transformed the financial performance of the banking industry by reducing the risks and at the same time allowing for introductions of new products. Therefore, bank has an avenue for growth in the short and the long run. Body Keynes is one of the proponents of the theory of income determination.14 He argues that national income is subject to a time of prosperity followed by times of depression. In his analysis, Keynes demonstrated the historical performance of the world economy and noted that when there were full employment and industry were thriving, soon thereafter the economy would suffer from shortages, unemployment that lead economies into a state of depression.15 Thus, this is what is synonymous to almost all sector of the economy. The banking industry does best explains Keynes scenario of burst and boom.16 Moreover, it is argued that the embracement of noninterest income is as a result of the burst that affected the industry in time of depression. Therefore, bank innovated ways of cautioning their income from losses and thus remain in their projectiles profit path. According to Keyne, economic sectors can achieve a high level of return or income when they change their magnitude of investments.17 In his analysis Keynes argue that a country or a given sector can increase it income when changes their capital, state of technology while maintaining the same business organization.18 Furthermore, Keynes assume that the market is free from interference from the government, there is fair competition, and the economy is closed from the outside completion.19 Therefore, under this consideration, Keynes argue that the economy of the country or a given sector will be at full employment when saving are equal to the level of investments.20 According to Keynes, the use of the interest rate to adjust the economic situation was a misplaced theory by the classical economists.21 Keynes disputed that changing the interest rate can bring about changes in saving and investment. Keynes resolved the problem that classical economist failed to answer about the depression of the 1930.22 In the short-run, industries income are determined by the forces of demand and supply, and it is in full employment when the aggregate demand equals aggregate supply.23 Bank, therefore, do follow the theory of Keynes to maximize their earnings. The Keynesian theory explains the trend in the banking sector from non-reliance in the traditions means of production where income were determined interest rates to the current noninterest earning. The demand for bank services in the financial market as well as value added products such as credit and debit card prompted the bank to shift their operations. However, the consumer demand for banking’s services is explained by ‘the principle of effective demand.’24 The principle of effective demand argue that the level of income or output produced in a given industry is determined by the willingness of people, government and firm to spend on the available goods and services.25 According to Keynes, a failure of willingness to spend by consumers result to diminished income and overall output.26 Researchers have attributed factors that influence the changing banking income and their profit structure. According to Busch and Kick, the accelerated globalization has played a big role in increasing the level of international trade.27 The increased in trade, therefore, necessitate demand for fee business. Banks, therefore, got a new opportunity to offer fee business to businessmen earning in return the charges for the services.28 The bank also ventured to asset management for their customers as well as investing banking. The changing structure of doing business by bank have brought down the cost of operations. Today every bank has its automated machine, and customers are accessing banking services through the internet. Therefore, the banks have reduced their manpower to embrace the new technology effectively. In addition, the costs of collecting data and another important information in the banking industry has decreased tremendously and thus bank are now relying on an efficiently collected information in their databases. For these reasons, the income in the banking industry has been growing from the 1980s until today and will do so if they keep on diversifying their operations to the market demand.29 Conclusion Income determination is influenced by different factors in the economy. Moreover, income is subject to the dynamics of the market and the changes in technology. The banking industry has seen it source of income change from charges on loans and interest rate on overdraft to selling of bank products. The demands for travellers check, for example, has assured banks of noninterest income while at the same time diversifying on other products that have become profitable more than the interest rate credit advances. Therefore, the changes in the financial market can be attributed to Keynes presumption that aggregate demand and supply dictate the level of employment.30 Bibliography Busch, Ramona, and Thomas Kick. n.d. "Income diversification in the Germany banking," socialpolitik.ovgu.de. Accessed September 22, 2014. http://www.socialpolitik.ovgu.de/sozialpolitik_media/paper_update/Busch_Ramona_uid373_pid325-p-535.pdf. Greenawalt, Mary Brady, and Joseph F Sinkey. 1988. "Bank Loan-Loss Provisions and the Income-Smoothing Hypothesis: An Empirical Analysis, 1976-1984." Journal of Financial Research 301-318. Keynes, John Maynard. 2014. The General Theory of Employment, Interest, and Money. Adelaide: Adelaide. Mitroi, Adrian, and Alexandru Oproiu. 2013. "Analysis of the correlation between the evolution of the consumer loans and the evolution of household income in Romania." Theoretical and Applied Economics 67-82. Young, Robert De, and Tara Rice. 2003. "Noninterest Income and Financial Performance as U.S. Commercial Banks." The Financial Review 1-37. Read More