Macroeconomics Theory - Case Study Example

How to Stabilize Interest Rates Lowering interest rates will counter consumer’s pessimistic view on the economy, and thus they will purchase goods available locally rather than purchasing imported products. People hold money as a store of value, conduct transactions and precautionary reasons. As interests rates go higher, people are less willing to hold money because it opportunity costs increases, as portrayed by the graph below.Interest rates Money supply Money demand Quantity of Money2. To reduce increase in household consumption, I would increase interest’s rates, in a bid to discourage consumption, and encourage savings because rewards for saving will be higher.3. One of the major policies FED should practice to achieve desirable interest rates at varying economic times is independent policy.

They should acknowledge the time inconsistency fact, and set up an independent policy, that which is not controlled by central government. Through this, policy makers should find it in public interest, to keep interests rates low, to keep down consumers and businesses expectations on inflation. This would maintain labor compensations relatively cheap, which would in return maintain favorable prices and increased output in the market.To ensure success of such policy, government should oversee that the independent policy makes full discretion to the public all relevant information when adjusting monetary policy, which causes adjustments of interests rates.

Inflation rateAutonomous inflationactual inflation Output gap Actual output potential output Real GDPFrom the graph above,this paper suggests that when the real inflation is controlled by an independent policy, interest rates will adjust with prevailing economic times, and the output gap is filled through provision of labor at favorable market prices.