The Conventional and Unconventional Tools Used by Central Banks - Essay Example

BUSINESS ECONOMICS BUSINESS ECONOMICS a) the conventional and unconventional tools used by central banks. Monetary policy tools are means through which the central banks control the supply of money. These can be aimed at either increasing the money supply or tightening the same. There are four conventional ways used by central banks to control money supply. Federal funds rate is the rate at which one financial institution can obtain surplus cash reserve from the other to fulfil the daily cash reserve requirements that the central bank requires. Demand forecasting is used in order to determine this rate and it is an effective tool of controlling monetary supply. Open market operations involves the buying back or selling of government securities. Of the government wants to increase the supply of money it will buy back the securities it has sold to financial institutions in exchange of currency that will then be circulated in the market in the form of investments or lending. If the government wants to decrease the money supply it will sell its securities and holding onto the money that was previously in circulation. Another way to control money supply is to adjust the rate of lending at which the banks can obtain loans from the central bank or other banks. Higher rate will result in low borrowing and hence tightened money supply and vice versa. Lastly, Cash Reserve requirement is also adjusted in order to control money in circulation. Cash reserve is the amount of funds that the financial institutions are required to keep aside. This is a percentage of the total deposits and higher cash reserve requirement allows banks to lend out less funds. Similarly lower cash reserve requirement enables banks to have more funds to lend out. Unconventional tools of money supply include the central bank’s commitment to keep rates low in the future. Another means is to adjust the central bank’s assets to provide ease in credit through the change in different rates and prices. Third unconventional way is lower the policy rate to zero by supplying reserves that are more than the required rate (Highered.mcgraw-hill.com, 2011). Money supply is a crucial aspect that determines the value of currency and inflationary measures. Conventional ways are the standard means for the central bank to control money supply. However, if the economic conditions do not permit the central bank to use the conventional means they resort to unconventional means which are effective but not good for the economy in the long run due to their unpredictable and risky nature. (b) In a 2012 study the International Monetary Fund (IMF) reported that the fiscal multiplier for the periphery of the Eurozone was roughly equal to 0.5. One year later, IMF recognised its mistake reporting that the fiscal multiplier was approximately equal to 1.7. Discuss the above statement explaining what the fiscal multiplier is. A fiscal multiplier shows the impact of change in government spending on the overall economy. It is means to shows how much a 1% change in government change will impact the GDP. Economists claim 6hat the fiscal multiplier is ideally 1, i.e. 1% increase or decrease in government spending will result in one percent increase or decrease in the overall GDP of the country. Before the global recession the IMF claimed that the fiscal multiplier was to be roughly around 0.5. However, after the great recession, the IMF accepted that the predicted fiscal multiplier was in fact too low. According to the international monetary fund(IMF)’s publication called World Economic Outlook, the chief economist Olivier Blanchard claims that after the global recession, it was studied that in 28 economies growth rate has slowed down to lie between 0.4 to 1.2%. Thus the actual multiplier had to be higher to lie between 0.9-1.7. This is because debt is a major component of the fiscal structure and the previously quoted 0.5 would have meant that a 1% increase in government spending would increase debt by 1% but the GDP will only grow by 0.5% thus, the policies that entail budgetary adjustments through government spending cuts and increase in taxation were to be affected too. After these austerity policies were seen failing in the major countries of the world the IMF claimed that they had estimated growth too optimistically and lack of anticipation of the great recession had led to this mistake on their side. They added that Eurozone periphery lied close to the higher end of the new range of fiscal multiplier that was proposed i.e. 0.9-1.7. Also the authenticity of austerity measure that are aimed at bringing the government expenditure and revenues close together were also challenged, The extent of impact that this multiplier has on the GDP cannot be determined exactly. And IMF’s approach has been greatly criticized for not considering the various changes that may occur in the world economy like recession. However, the past data does signify the exact impact that this multiplier has on a given economy. Fiscal multipliers take into account the interest rates and government spending. Sconce defines spending is the most; it is taken as a key variable. If the government wants to bring about a change in the multiplier it has to adjust the total spending on defines. Thus, it can be said that the IMFs proposed fiscal multiplier has been a result of a fairly conservative outlook (Hart-Landsberg, 2012). Thus, in an economic point of view, the great recession brought about significant slumps in the growth of the Eurozone periphery. These were not anticipated and hence, when the interest rates dropped and economic activities slowed down, the GDP was affected negatively too. Lending was resisted by the financial institutions, investment was postponed and savings increased. For example, according to the Eurostat data, in Greece the fiscal contraction was aimed at relieving the debt burden of the economy, but instead of lowering the debt they faced an increase in it and a slump in GDP growth (Europe and Europe, 2012). This is just one of the many scenarios that resulted after the recessionary period. Thus, an adjusted economic strategy had to be put in place to revive the economies of the recession-struck Eurozone in order to side track the repercussions of the negativity of the recession that still prevails. 2) (a) Discuss the different types of unemployment. Unemployment refers to joblessness that occurs when a person is unable to obtain a job or is seeking one. It is a negative element in any society as it entails the wastage of (human) resources that could be productive otherwise. Different kinds of unemployment are: Structural unemployment occurs when the amount of available workers exceed the actual demand for such workers. This could occur due to a change in technology or a firm’s overall priority. Frictional unemployment occurs when people move between jobs or locations. These are usually temporary in nature and account for the productive time lost between the switch. Cyclical unemployment refers to the one that occurs when the unemployment rate is oppositely affected by the GDP growth rate. For example increase in GDP growth rate will bring down the unemployment rate. Similarly in recessionary times unemployment goes up, which is an example of cyclical unemployment. Seasonal unemployment occurs for seasonal occupations that have lack of demand in the off season. Apart from these, other kinds of unemployment are regional, classical and voluntary (Economicsonline.co.uk, 2014). (b) According to ‘The Office for National Statistics UK’, unemployment is reduced with optimistic prospects for 2014. Which type of unemployment is responsible for this reduction in the unemployment rate? Explain your answer. Since the recession in 2008, employment sector was also affected negatively making millions of people jobless. Apart from recession the prevalent unemployment was also attributed to the emerging technology and the evolution of the part time trend. When firms looked to cut down on their costs and many even dissolved, leaving their staff unemployed and vulnerable to the pressures of a falling economy. However, the rate at which the employment rate has picked up in the recent times in the UK is phenomenal compared to the recessionary patterns of yesteryears and to the rest of the Eurozone. Many firms have expressed their interest and positive intention to open up their firms to workers and expand to offer employment to the masses. The effects are evident from the fact that according to the national statistics, the unemployment rate has dropped down to 7.6% which is the lowest it has touched since the recession hit the UK economy 3 years back. According to a survey conducted with 325 organizations operating in the UK, more than a million people have been employed in the past few months and plans to expand their workforce within the next 12 months are also underway. Out of the firms studied one third intended to target the fresh graduates much to the relief of the new flow of human resource to enter the market (Dominiczak, 2014). This unemployment can be attributed to a blend of structural and cyclical unemployment that resulted because of recession. Recession brought about cost reduction trend in the employment sector and the demand lessened. Slow GDP growth hampered the creation of jobs and the new influx of young graduates joined the unemployment bandwagon as well. However, the newest trends show that the economy is picking up and the prospects of employment on 2014 are bright. Apart from the conventional employment areas, creative industries are also considered as an emerging employment creator with computers, media, arts and creative works being the centre of focus worldwide. (c) Imagine yourself as Chief Economist of World Bank at their London headquarters. One morning you are informed that the OPEC countries made and agreement according to which they are going to reduce the produced quantity and to increase the price. What impact such agreement would you expect to have on the UK economy? In your analysis use a diagram. Oil is an important fuel and energy sector requirement for any developed or developing country. For a country like UK that is a significant oil importer and has many industries running on the basis of this kind of fuel, such a measure by OPEC countries would have a drastic impact on the UK economy. If the quantity of oil produced is lessened, the demand will remain the same and the supply will decrease, increasing the price it is offered at. Since it is a fuel necessity, the price will be paid as quoted by the OPEC countries. Oil price hike can impact the economy on three basis; household, business and government (Tverberg, 2013). An average person has to deal with inflation as almost every commodity is prices higher than before. This is because the means of transportation become expensive and this cost is passed down to the consumers. With lesser money to spend, spending decreases for other commodities like leisure, travel, housing etc. Businesses have a higher cost of operating and this may lead to a stringent policy that entails layoffs and salary cuts. Government expenditure increases with high import prices for oil which is a source of many industrial activities. This means lesser spending on welfare, education or other sectors or an increase in taxation. Thus, a rise in oil prices from the suppliers will lead to a disruptive economy and give birth too many economic issues in UK. References: Tverberg, G. 2013. Ten Reasons Why High Oil Prices are a Problem. [online] Available at: http://ourfiniteworld.com/2013/01/17/ten-reasons-why-high-oil-prices-are-a-problem/ [Accessed: 10 Mar 2014]. Highered.mcgraw-hill.com. 2011. Monetary Policy: Stabilizing the Domestic Economy. [online] Available at: http://highered.mcgraw-hill.com/sites/007337590x/student_view0/chapter18/ [Accessed: 10 Mar 2014]. Hart-Landsberg, M. 2012. 2012 October at Reports from the Economic Front. [online] Available at: http://blogs.lclark.edu/hart-landsberg/2012/10/ [Accessed: 10 Mar 2014]. Europe, W. and Europe, W. 2012. Women Economists for a Fair Europe: The fiscal multiplier and austerity in the eurozone. [online] Available at: http://women-economists-for-a-fair-europe.blogspot.com/2012/11/the-multiplier-liquidity-trap-and.html [Accessed: 10 Mar 2014]. Economicsonline.co.uk. 2014. Unemployment types and causes. [online] Available at: http://www.economicsonline.co.uk/Managing_the_economy/Unemployment_types_and_causes.html [Accessed: 10 Mar 2014]. Dominiczak, P. 2014. Increase in employment will bring peace of mind to UK, David Cameron says - Telegraph. [online] Available at: http://www.telegraph.co.uk/news/politics/10589179/Increase-in-employment-will-bring-peace-of-mind-to-UK-David-Cameron-says.html [Accessed: 10 Mar 2014]. Read More