The Effect of an Increase in the Money Supply - Essay Example

According to Keynes, the money supply is fixed by the government, and the size of the money supply is perfectly inelastic concerning interest rate changes. A decrease in the money supply from MS1 to MS2 leads to an increase in the interest rate from i1 to i2.

1. In the rest of the economy, the sale of government securities will lead to a reduction in Gross Domestic Product (GDP). General Price levels will decrease leading to a decline in the level of inflation which may make the economy go into a contraction and recession (Langdana 100). The situation can also lead to an increase in the levels or rates of unemployment.

Question 2

1. Expansionary fiscal policies have short- and long-term impacts on the aggregate economy as well as on the balance of the federal budget. Expansionary fiscal policies involve the attempts of the government to increase the aggregate demand. It will therefore include higher government spending or reduction of taxes to increase demand and spur economic growth. Reduction of taxes will lead to an increase in the consumer’s disposable incomes which then leads to a high level of consumer spending (Langdana 100). This then increased the aggregate demand leading to high economic growth. The expansionary fiscal policy road to an increase in the size of budget deficits in a government. This is because the higher borrowings by the government will cause the market to fear default and push up the rates of interest on government debts.

Graph 2: Expansionary fiscal policy

1. The expansionary fiscal policies were adopted to stabilize employment rates, inflation, economic growth, and national output. There is no tradeoff between inflation and unemployment as increased government borrowing may increase inflation rates which will then lead to high levels of unemployment.

Question 3

There are various types of budget deficits and they include the primary deficit, fiscal deficit, and revenue deficit. A revenue deficit occurs the amount of revenue received is short of the expected amounts. A fiscal deficit occurs when the expenditure by the government surpasses its projected revenue (Langdana 100). A primary deficit occurs when the government borrows money from lending institutions to cover its expenditures. The interest payment which is then subtracted from the fiscal deficit amount is referred to as primary deficit. A budget deficit occurs when the government spending is higher than the collections Persistent budget deficit leads to economic depression which means that the rates of unemployment will be very high as well as the inflation rates. Without balanced trade, deficit spending is a small defense against high unemployment rates.

Question 4

1. Fiat money can also be referred to as forced paper money, debt money, or managed money and can define as money that does not have intrinsic value and cannot be redeemed for any commodity. There are two ways in which fiat money differs from commodity money. In the commodity monetary system, money supply usually adjusts automatically to the monetary needs while the supply of and demand for money usually react simultaneously through the prices for services and goods in the market to determine the specified quantity of money. Under a fiat monetary system, the supply for money is artificially regulated through the government or its central bank. The government also decides how much to create and how much to issue. Secondly, commodity money value is directly related to the material in which it is made while in fiat money, the value does not depend on the material and depends on supply and demand for money.
2. One advantage of commodity money is that it has value will always be consumed regardless of the market status. One advantage of fiat money is that its value can be increased in a period.
3. Money was invented as a medium of exchange and to ease trade

Question 5

Federal Reserve is a politically formed formal organization in the USA which h implements its monetary system. Its main functions are to set the monetary policy for the nation and also provide emergency liquidity to the country to prevent a collapse or a recession in the country. It also regulates the amount of money supply going into the economy (Langdana 100). Federal Reserve or Fed is important to the average American as it formulates monetary policies regulates interest rates, stimulates aggregate demand, and prevents high rates of inflation making people’s lives better.