Economics Assessment - Assignment Example

ECONOMICS Table of Contents ECONOMICS Macroeconomic Shocks: Insufficient Demand Cases 3 Monetary Policy 5 Fiscal Policy 7 Policy Issues 9 Bibliography 10 Macroeconomic Shocks: Insufficient Demand Cases There are two factors of demand pull inflation. First one is real factor which is happened by demand based recession and the other one is monetary factor which is based on money and credit caused recession. The first macroeconomic shock is demand based recession. It happens because of decline in the aggregate demand. There can be two reasons behind it. One is the primary factor where the tax rate may rise with unchanged government expenditure or government purchase may get low with unchanged tax-rate. An undesirable condition will arise when tax rate will increase with low government purchase of current domestic product. Even recession in other foreign countries also have an effect in demand of a product of United States. After falling of aggregate demand, if there are no chances of raising it, then the producers will bring down the production level and to maintain the cost they will lay-off employees. This leads to increase in unemployment. As output is low, the demand for money will also get lower and that is why interest rate will be low. Here, price level will be become unchanged. The second shock is based on money and recession caused by credit limits. It is mainly caused for the low money supply and velocity with rises in price index. The reason behind it is tightened monetary policy where financial institutions try to reduce the amount of loan. As the money supply is low, the interest rate will become high which directly affects the demand for goods. And again same as demand caused recession the output and employment will be low. The third shock is cost- push inflation. It occurs mainly because of increase in the cost. At the first stage, it happens because of the raise of wage which ultimately raises the cost and then the price also. So, demand will become low and a result of that production will also be low and employment will get effected. Because of high level of price demand for money will raise which means interest rate will also rise. These are the effects of cause - push inflation. Growth problem indicate the higher level of gross domestic product (GDP). However, GDP increase the demand for money and so the interest rate becomes high but the demand for goods is comparatively low that is why producers start producing less which brings down the output as well as the employment. Ultimately the demand for money will become low which will lead to fall in interest rate. It is not necessary that inflation will happen because of the money every time; it can be caused by demand also. The relationship between inflation and unemployment depends upon the term. In short run, it may be positively related but in long run for taking corrective actions it may be negatively related. Monetary Policy There are three independent sectors which forms the base of any economy. Those are household sector, private sector and government sector. As the household sector has their consumption and earnings, the other two sectors have income and expenses. The link can be created as the wages and salary come from government and private sector generates income for household sector. This leads to consumption. Consumption again creates demand for goods. Production level and employment both are dependent upon the demand. It leads to income of private and government sector which is again related with the income level of household sector as well as government sector (as tax). This is the coordination of macrocosmic process. From this link it can be said that GDP, ASF and APE are dependent on these sectors. Federal Reserve Banks (FRB) is the part of Federal Reserve System. As the annual revenues of these banks are too high, so FRBs have contribution in emergency fund and in financing federal government programs. Federal Reserve System not only controls the nation’s money supply but also carry out fiscal services for the federal government. FRBs also act as an U. S. Bankers for other international agencies and foreign governments. They played a role of a banker’s bank as the central bank of a country. There are mainly four economical factors (price, employment, interest rate and output) which should be balanced at every mode of time. Monetary policy has been taken by Fed to control these factors through some economical mechanism such as open market operations, alteration in discount rate and adjustments in reserve requirements. They use any one of these to adjust the money supply (M) of the nation and interest rate. This leads to change in ASF. Thus, through macroeconomic coordination process the ultimate results of economic factors came up. Fed controls the monetary policy directly, focusing on three things. The monetary base denotes the reserve plus coins and currency component. r’ is the required average number of dollars on reserve per dollar checking deposit. r” is same as r’ but on time deposited. Fed control B through open market operations and maintain r’ and r” within a range specified by Congress. It indirectly influences w (working reserve) through open market operation and adjusting discount rate. Fed focus on the changes in w by banks and changes in d and t by the public, for achieving and maintaining effective control on money supply. The open market operation is nothing but the sale and purchase of the securities of the United States. Treasury and U.S. government agencies control the fully guaranteed securities to control the money supply. Fed sales it at the time of inflation and purchase it at the time of recession. Reserve Requirement Adjustment is to fix up a particular range of reserve upon bank deposits. This range is set up by Congress. By increasing the reserve requirement they can check the inflation and vice versa. Discount Rate Adjustments is done through increasing or decreasing the rate of interest on lending and borrowing loans. By increasing the discount rate banks allow more deposit and less borrowing and vise versa. Thus, Fed can control the money supply. The monetary policy had been broken into two parts as per need of the money supply. Ease monetary policy is for pushing more money to the economy by open market purchase, cutting down reserve requirements and discount rate. Tight monetary policy is a weapon of fighting against the inflation. Fiscal Policy Government can influence the economic activity through its expenditure program or with taxation. Fiscal policy comprises these factors. Unlike, monetary policy the Congress has built up its own fiscal policy, which has two parts namely Automatic Stabilizers and Discretionary Fiscal Policy. Regarding automatic stabilization, it tries to control the movement of APE and GDP through government expenditure, tax rate concession and with few of the compensation programs. APE, GDP and GDY are interrelated. The movement of APE and GDP in macro economic coordination is linked with tax. Changes in tax rate bring changes in GDY and APE relationship. In simple way, it can be understandable as income is rising and tax rate will become same then, income after tax will raise that leads to rising of purchase or the aggregate demand. So, with increasing GDY, APE will also increase if tax rate becomes same. Automatic Stabilizers follows a “Reservoir Principle”. It refers to a reservoir which is filled up by the taxes and drained its fund by the outflow of the benefits. When income will increase, the tax inflow will also increase and the reservoir will become full and that time there will be no need of providing compensation but when the income will become lower, the tax inflow will also low and then the need of providing compensation will rise. As a result, amount of fund in reservoir will become low (as outflow > inflow). The ultimate motto of automatic stabilizer is to stabilize the aggregate demand. For that the government should take right decision regarding the tax rate and the transfer rate at right time. The effects of the tax rate and transfer rate in level of income purchase can be shown as follows: Low income > Same Tax Rate + No Compensation > Low Level of Purchase Low income > Low Tax Rate + No Compensation > Increase the Purchase Level Low Income > Low Tax Rate + Compensation > Comparatively Higher Level of Purchase. Thus, the affect of low income can be avoided as well as the stability in purchase level can be brought into. In case of Discretionary Fiscal Policy, the economic factors such as unemployment and inflation have been affected by the changes of APE as APE = Consumption + Government Expenditure + Investment. That is why, federal government bring certain changes in current domestic output purchase and tax receipt both from households as well as businesses. The ultimate destination of fiscal policy is to equalise the aggregate demand with the targeted GDP. For that they need to adjust their tax receipt and current domestic output purchase. The result can be negative or positive. If fiscal policy is not able to equalize APE with targeted GDP then expansionary fiscal policy should be taken, otherwise government should go for restrictive fiscal policy. Here, a link has been found between monetary policy and discretionary fiscal policy. Both have a same destination of low unemployment and inflation. Discretionary fiscal policy creates a scope of many alternative changes which creates more political issues and it may be time consuming and can be followed by a negative impact on economy. So, it was recommended to stick in one option either monetary or fiscal policy but it is not a feasible idea again. That is why; the federal government should take one fiscal policy and give more emphasis on tax rebate. Policy Issues Certain action has been taken by government for inconsistent problems. For demand caused recession where APE falls, the government have to go for expansionary policy. They must ease the monetary and fiscal policy. It mainly refers to reduce the tax limit, expanding government expenditure and purchase open market securities. Very often liquidity trap also takes place. It refers to the situation where with the increase in money supply interest rate does not fall and interest elasticity of demand for money becomes infinite. It is caused because of severe recession. Crowding out effect means a tendency for a rising in government purchases of goods and services to bring the decrease in investment. It happens because of expansionary fiscal policy. Where the policy tries to increase aggregate demand but they are unable to increase the aggregate supply of fund. Bibliography Western Oregon University. “Economics”. May 27, 2010. Introduction to Macro Economics. No Date. Read More