Credit Counterparts of Broad Money - Essay Example

Credit Counterparts of Broad Money and Their Relevance in Macroeconomic PolicyIntroductionThe aim of this essay is to explore the credit counterparts of broad money and their relevance to macroeconomic policy. Among the items am going to examine are net credits to governments, net credits to the private sector, and adjustments to foreign reserves. For many years, broad money was assumed to be the only item that affects the passing of macroeconomic policies as drawn out by the IS-LM model. Unfortunately, the supply of money does not capture all aspects of monetary macroeconomics.

Government lending to governmentsThe effect of a government loan to another government is a reduction in the money supply in the economy. Based on the IS-LM model, it is apparent that reducing the supply of money shifts the LM curve to the right thus moving the equilibrium interest rate upwards and the level of national output downwards. On the macroeconomic level, the government can use this item of the Broad money counterparts as a macroeconomic policy to curb inflation or unsustainable increases in national output (Congdon 2007, p.36). The policy can be used as a contractionary fiscal to reduce excess liquidity in the economy and control inflation.

Excess liquidity refers to a situation where the money being held by the public is in excess inducing excess spending and hence excess demand. The excess demand to supply can cause an unhealthy price increase.Foreign reservesForeign reserves are adjusted using the surpluses of trade that is a stimulus to increase exports thus increasing the foreign reserves while an increase in imports decreases the foreign reserves. Changes in foreign prices in countries largely dependent on international trade have a significant effect on the money supply, inflation, and national output.

The increase in the prices of imports will result in inflationary pressures in the economy. On the contrary, an increase in export prices will cause an increase in the profitability of the export goods and hence a shift of resources in the production of export goods. The change in import and export prices affects a countries balance of payment situation (Congdon 2007, p. 46). The government can control national output and inflation through fiscal policies regulating imports and exports. When the balance of payment has been offset by over importation, the government can curb the inflationary effects by introducing higher tariffs that will adjust imports to a sustainable level.

In cases where the government wants to stimulate economic growth through simulation of inflation to a sustainable level, imports of production inputs have an inflationary effect on the goods produced based on the inflation rate of the country they are sourced from. This is done through the relaxing import tariffs this will increase the level of imports lowering the supply of foreign exchange reserves. To increase production in imports calls for fiscal policies that restrict imports and encourage exports a reduction in export duty will increase the level of foreign reserves also another tool of controlling the balance payments situation.

Government lending to private sectorThe effects of government credit to the private sector are same as those of increased government spending and have an expansionary effect on economic growth. Increased lending will increase liquidity in the economy, stimulate spending in the economy and cause an effect economists refer to as the multiplier effect. The lending to the private sector is by itself a monetary effect together with being a credit counterpart of the broad money.BibliographyCongdon, T 2007, Keynes, the Keynesians and Monetarism.

Cheltenham, Edward Elgar