Politics as One of the Determinants of the Stability of the Economy - Essay Example

QUESTION ONE Demand for money is the desired holding of financial assets in the form of money. In this context, money can exist in form of cash or bank deposits. Demand for money can be narrow defined as M1 (non-interest-bearing holdings) or for money in the broader sense of M2 or M3 (Plassmann, 34). There are three types of money demand which include: Speculative demand for money. This arises when people hold money to purchase assets. That is; holding money for investments is called speculative demand for money. Investors speculate about the interest rates in the future and they purchase assets and for speculative measures money is demanded. Transaction demand for money. This is a situation where people hold money to purchase goods and services. This is the most common form of money demand as each and every individual in the world demand money to pay for services and goods for consumption. Precautionary demand. People hold money in case they need to spend it. Unexpected bills or a spur of the moment purchase may result to holding a little extra money in case. Demand for money exhibits a negative relationship with the nominal interest rates. As the interest rates increases decrease, the demand for money increases. When the nominal interest rate decreases, the result is less attractive bonds (Langdana, 34). If a person gets a lower interest rate on the investment, he is more likely to trade those investments in for hard cash. Rising real incomes and increasing numbers of people employed will increase the demand for money at each interest rate. The transaction demand for money is positively related to inflation and income. An increase in a person’s income rises or as the prices increases, he will hold more money that will enable him carry out his daily transactions. QUESTION TWO A variety of methods and policies have been used to mitigate inflation. For moderate information I would recommend the following monetary policies and fiscal policies: Monetary policy- in controlling the inflation in the economy, I would recommend that the central bank lowers the lending rates, normally to a target of around 2-3%. Monetarists emphasized on keeping the growth rate of money steadily and using monetary policy inflation. They opted for slowing the rise in the money stock, and increasing interest rates. The next recommendation is to adjust the real wage. Increase in inflation makes get pay rise to offset inflation. However their real wage remain constant and hence the purchasing power is not lost as long as the nominal wage rise keep up and wages does not fall. QUESTION THREE Monetary policy is the process by which the Central Bank of a country controls money supply that targets the interest rates for the purpose of enhancing economic stability and growth. Tools of monetary policy include: Reserve requirements- this is the case where the monetary authority applies regulatory control over banks. This policy requires that the commercial banks maintain a certain level of reserves (cash) with the central banks. The amount reserved changes depending on the change on the regulations by the central bank. Monetary base- this include implementing monetary policy through changing the size of the monetary base. The central banks utilize the open market operations to change the monetary base. This policy will affect all the players of the economy such as the investors and the banks. Interest rates- the contraction of the money supply can be indirectly realized through increasing the nominal interest rates. The discount rate, as set by the central banks, has viral effect on other market interest rates. Through increasing the rate of interest under its control, the central bank can contract the money supply, for the reason that higher rates of interest encourage savings and discourage borrowing hence reducing the size of the money supply. This policy will affect both the consumers and the producers in the economy (Müller, 88). The federal monetary policy maker must balance price and output objectives. The central bank, same to ECB, which target targeting inflation, would agree that they must pay attention to stabilizing the output and keeping the economy at full employment. Therefore the Fed should focus on price stability, stable foreign exchange, lower interest rates and increased investments to stabilize the economy. QUESTION FOUR The increase in cost of living has different effects in transfer payments, AD, AS, Prices, employment and real GDP. When the COLA increases, the number of transfer payments will be reduced. The demand of the economy is defined in terms of the purchasing power of the economy’s population (Müller, 56). COLA reduces the welfare of the population and hence reduced aggregate demand. If the aggregate demand of the economy increases, the aggregate supply will also increase. Therefore, increased cost of living will reduce aggregate demand, reduce aggregate supply, reduces the employment level and through the multiplier system reduces the real GDP. QUESTION FIVE If the Federal Reserve banks mails 300 million people a new bill of $100, the prices will increase. This is because the money supply will increase at a higher rate than the production of goods and services rate, hence inflation. The income will increase. The output will not change in the short-run because business will need time to adjust to the new demand. However, in the long-run the output will increase. Money supply= 100*0.9*300= $27000 million QUESTION SIX Interest rates have been driven down on everything form mortgages to bank accounts. But it is clear that borrower’s still pays high interest on credit cards (Schug et.at, 67). The main reason why the interest rates on credit cards have remained relatively high is because they are riskier products where the lender has to be compensated for the risks they are assuming. The credit cards are pegged to the prime rate, which has been around 3% since the start of 2009. Additionally, as like other loans, credit cards are not essentially paid down overtime hence high interest rates. QUESTION SEVEN Politics is one of the determinants of the stability of the economy. Most economic agents are politically influenced. The fiscal and monetary policies are also influenced by the political factors. Politicians are mostly interested in agreements and policies that will give him a political mileage and advantage over his competitor. Therefore, in this situation the politicians have no choice but to set a lasting agreement that will enable the economy go over the cliff. This is because if the economy plunges back into recession, even the politicians will suffer in terms of their power ambitions. References Langdana, Farrokh K. Macroeconomic Policy: Demystifying Monetary and Fiscal Policy. New York: Springer, 2009. Internet resource. Müller, Christian. Money Demand in Europe: An Empirical Approach : with 46 Tables. Heidelberg [u.a.: Physica-Verl, 2003. Print. Persson, Torsten. Politics. Cambridge, Mass. [u.a.: MIT Press, 1995. Print. Plassmann, Engelbert. Econometric Modelling of European Money Demand: Aggregation, Cointegration, Identification. Heidelberg: Physica-Verlag Heidelberg, 2002. Print. Schug, Mark C, and Richard D. Western. The Great Economic Mysteries Book: A Guide to Teaching Economic Reasoning, Grades 9-12. New York, NY: National Council on Economic Education, 2000. Print. Read More