Economic Analysis, Rule-Based Approaches - Essay Example

Macroeconomics (Question a) There is always much debate on the concept of rule versus discretion in regulating aggregate demand. The origin of this debate is traced back to Milton Friedman’s assertion that the Federal Reserve should increase money supply in the economy by a fixed rate annually as opposed to the traditional approach where there was much discretion on the issue of money supply. In any case, this choice is not merely limited to controlling money supply or financial regulation. In monetary policy, discretion is normally essential in offsetting output fluctuations often realized in Keynesian frameworks. In this respect, most monetarists usually propose the use of a fixed rule in ensuring price stability in the economy. In terms of agent’s utility, discretion based solutions are normally the best. On the other hand, policy options that are based on rules usually have little room for policy errors. However, such an approach requires a lot of confidence that the variables will perform as intended without any challenges. This is certainly difficult to realize for inflation targeting especially in the identification of financial stability (Langdana, 2009). Indeed, most rule-based approaches have faced many challenges especially when applied as an inflation target framework. In this respect, a discretionary framework is always appropriate in addressing the issue. It allows policy makers to learn much from the interaction between various relevant stakeholders. Nevertheless, it should be realized that the adaptability and flexibility of discretion comes with its own share of costs. There is limited predictability of the decision in addition to a tendency toward forbearance as policy makers are tempted to postpone backfiring decisions. In most rule-based approaches, policy reactions are normally left to some pre-defined automatic triggers and mechanisms. However, the use of rules might be difficult especially for a new policy which should be used across the world (Peston, 2010). (Question b) Indeed, the Taylor rule has greatly revolutionized the manner in which policy makers and central banks approach the issue of monetary policy. It frames policy actions in line with the various incoming information regarding economic conditions. In this case its contrasts the traditional period-by-period optimization problem. The rule has greatly brought into focus the need for adjusting policy rates more than one-for-one in responding to increased inflation. The rule is therefore used in adjusting prudent interest rates which can help in stabilizing the economy both in the short term and maintain growth in the long term. This is much opposed to inflation targeting which basically focuses on estimation of the inflation rates and attempting to fix the situation through interest rates (Barro, 2005). The attractiveness of the rule arises out of its ability to foster price stability and ensure full employment through a reduction of uncertainty. It further increases the credibility of future actions of the central bank. The rule might further avoid most inefficiency associated with time inconsistency through the use of discretionary policy. The Taylor rule indeed provided a compromise between the various competing schools of thought in a proper language often lacking in rhetorical passion. A recent application of the Taylor rule was made by the Federal Open Market Committee (FOMC) after inflation was seen to have risen by 2%. The rule provided a quantitative prescription on how the interest rates should be increased to address this change. Indeed, the Taylor rule has been important in addressing some of the challenges which conventional inflation targeting cannot reach. However, the rule also has its own challenges and is often used together with other approaches in real economic situations (Prachowny, (2011). Microeconomics (Question a) It is certainly true that firms prefer making more profits to less. Profit is certainly a very important concept in the operations of a business. While firms will normally have a number of objectives, profit maximization is always a core objective. Profit in this case is basically the financial return realized as a result of the risk taken. The success of investment is normally measured by the amount of profit it makes in addition to other factors. A higher profit therefore translates into much success for the firm. Considering that firms will usually seek more finance to expand operations, higher profits will always indicate better prospects for the business and banks and other financial institutions can therefore easily provide finance for the business. The focus of the financial institutions is basically to ascertain that the business is in a capacity to pay back the debts (Katz & Rosen, 2007). In the same way, profits can be retained within the business to provide a source of capital for expansion and other activities. In this respect, I certainly agree with the statement on the need to make more profits as opposed to less. It is further seen that the statements is much compatible with other alternatives to the profit maximizing theory of the firms. Firms will always seek to maximize profits, minimize cost and maximize revenue. In this case, cost minimization measures will always lead to a reduction in expense for the business which subsequently translates to increased profits. In the same way, as the firms seeks to maximize its revenue, it will expand its operations and higher revenue will definitely translate to higher profits. This compatibility is therefore very appropriate as it ensures that the firms can easily realize its goals without compromising on any (Maurya, 2008). (Question b) Indeed, in a world characterized by increased competition and other intensive market dynamics, many firms are facing challenges. The idea of putting people before profits is therefore seen to present a number of challenges due to the increased competition in the market. However it should be realized that people in this respect basically refers to the customers, employees and other human stakeholders in the business. It is always seen that when employees are motivated and treated well in an organization, they will also provide better services to the clients who boost the operations of the firms (Browning & Zupan, 2006). Considering that operations are conducted by people, it is only important to ensure that such people are treated well and they will definitely be loyal to the business. For instance at Northwestern Airlines, the focus is to treat employees in the sot appropriate manner and the benefits will trickle in all aspects of the business. When employees are well motivated, the business will definitely attract the best talent in the market which will translate to better services to the clients. This will lead to customer loyalty and hence increased profits. In this case, businesses should rather focus on putting people before profits (Miller, 2007). References Barro, R. J. (2005). Macroeconomic policy. Cambridge, Mass.: Harvard University Press. Browning, E. K., & Zupan, M. A. (2006). Microeconomics: theory & applications (9th ed.). Hoboken, NJ: Wiley. Katz, M. L., & Rosen, H. S. (2007). Microeconomics (3rd ed.). Boston, Mass.: McGraw-Hill. Langdana, F. K. (2009). Macroeconomic policy demystifying monetary and fiscal policy (2nd ed.). New York: Springer. Maurya, M. L. (2008). Modern microeconomics theory and application. Delhi: Manglam. Miller, R. L. (2007). Intermediate microeconomics: theory, issues, and applications. New York: McGraw-Hill. Peston, M. H. (2010). Theory of macroeconomic policy. New York: Wiley. Prachowny, M. F. (2011). The goals of macroeconomic policy. London: Routledge. Read More