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Macroeconomic in Finance - Assignment Example

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The paper presents the models of intertemporal trade, the effectiveness of fiscal and monetary policy and their dependence on the sensitivity of money demand to the interest rate in the closed-economy. It focuses on the importance of the interest elasticity of investment in policy effectiveness…
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Macroeconomic in Finance
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Download file to see previous pages The effectiveness of fiscal and monetary policies is dependent on the different variables in the economy. This section will look at the monetary and fiscal policy effectiveness in a closed economy. Monetary policy is “the government or central bank process of managing the money supply to achieve specific goals such as constraining inflation, maintaining an exchange rate, achieving full employment, or economic growth.” The monetary policy tools refer to the policy tools of the central bank used to affect the money supply and interest rates such as open market operations, changes in the discount rates, and changes in the reserve requirements (Mishkin 2004). It should be noted that the effectiveness of all these policies rests on the relationship between money supply and interest rate. Accordingly, an increase in the money supply tends to bring a reduction in the interest rate while a decrease in the money supply brings about a rise in interest rates. It is notable that without affecting the interest rate, monetary policy renders no effect on the economy. For example, a government wishing to eliminate unemployment pursues an expansionary monetary policy lowering the reserve ratio. This in effect will lead to excess reserve rates and encourages bank lending while increasing the money supply. Since the interest rate is inversely related to the money supply, the interest rate falls which encourages investment. Aggregate demand increases and unemployment is reduced or eliminated through the creation of jobs in the economy. In this example, it can be seen that without the reaction of interest rate in the increase in money supply, the monetary policy is useless and the economy will remain in its current position. ...Download file to see next pagesRead More
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