Sustainable Growth of the Economy - Term Paper Example

Macroeconomics Introduction Macroeconomics tells about the development in a country’s economy collectively consider the study of sum of individual economic factors. Moreover, economic designs are dependent on several macroeconomic factors. (Homes, 2002)A nation endeavors for a sustainable growth of economy in order to improve the lifestyle and living standards of its citizens. Even though, financial and fiscal policy is used that influences its economy; a well defined economic policy is capable enough to produce and maintain sustainable growth. A countrys balance of payment account records all transactions made by the residents of that country and rest of the world. These transactions enter as either debit items or credit items. The debit items include all payments to other countries: these include the countrys purchases of imports, the spending on investment it makes abroad and the interest and dividends paid to people abroad who have invested in the country. The credit items include all receipts from other countries: from the sales of exports, from inward investment expenditure and from interest and dividends earned from abroad. (John Solomon, Essentials of Economics, page 462-265) The sale of exports and any other receipts earn foreign currency. The purchase of imports or any other payments abroad use up foreign currency. If we start to spend more foreign currency than we earn, one of two things must happen. Both are likely to be a problem. The balance of payments will go into deficit. In other words, there will be shortfall of foreign currencies. The government will therefore have to borrow money from abroad, or draw on its foreign currency reserves to make up the shortfall. This is a problem because, if it goes on too long, overseas debts will mount, along with the interest that must be paid; and/or reserves will begin to run low. The exchange rate will fall. The exchange rate is the rate at which one currency exchanges for another. For example, the exchange rate of the pound into the dollar might be £1= $1.60. When all the components such as current account, capital account, financial account of the balance of payments account are taken together, the balance of payments should exactly balance: credits should equal debits. If they are not equal, the rate of exchange would have to adjust until they were, or the government would have to intervene to make them equal. In order to achieve the goals of high and sustainable economic growth, low unemployment, low inflation, a satisfactory balance of payments and stable exchange rates, the government may seek to control several intermediate variables. There include interest rates, the supply of money, taxes and government expenditure. The four main macroeconomic goals that are generally of most concern to governments are economic growth, reducing unemployment, keeping inflation low and stable, and avoiding balance of payments and exchange rates problems. (Case & Fair, Principles of Economics, page 688-691) How can government expenditure and taxation be used to affect the level of economic activity? Fiscal policy involves the government manipulating the level of government expenditure and/or rates of tax so as to affect the level of aggregate demand. An expansionary fiscal policy will involve raising government expenditure or reducing taxes. This will increase aggregate demand and lead to a multiplied rise in national income. A deflationary fiscal policy will involve cutting government expenditure and /or raising taxes. Fiscal policy was seemed to be the major way of controlling the economy; it was used to perform two main functions: To prevent the occurrence of fundamental disequilibria in the economy. In other words, expansionary fiscal policy could be used to prevent mass unemployment, such as that experienced in the Great Depression of the 1930s or in east and south-east Asia, Russia and Brazil in the early 2000s. Likewise deflationary fiscal policy could be used to prevent excessive inflation, such as that experienced in many countries in the early 1990s. (Hoffman, 2004) To smooth out the fluctuations in the economy associated with the business cycle. This would involve reducing government expenditure or raising taxes during the boom phase of the cycle. This would dampen down the expansion and prevent overheating of the economy with its attendant rising inflation and deteriorating balance of payments. Conversely, during the recessionary phase, as unemployment grew and output declined, the government should cut taxes or raise government expenditure in order to boost the economy. If these stabilization policies were successful, they would amount merely to find tuning. Problems of excess or deficient demand would never be allowed to get severe. (John Sloman, Essentials of Economics, page 311-312) A fall in the value of sterling (depreciation) means one pound now buys fewer dollars. Sterling depreciates if Americans demand fewer pounds (shown in the diagram below) or if UK citizens offer more pounds. UK exports become cheaper and UK imports become dearer. Hence, a sterling depreciation improves the balance of payments. A rise in the value of sterling (appreciation) means one pound now buys more dollars. UK exports become dearer and UK imports become cheaper. Hence a sterling appreciation worsens the balance of payments. The Gold standard related to Balance of Payments The gold standard was the major system of exchange rate determination before 1914. All currencies were priced in terms of gold-an ounce of gold was worth so much in each currency. When all currencies exchanged at fixed ratios to gold, exchange rates could be determined easily. For instance, one ounce of gold was worth $20 U.S.; that same ounce of gold exchange for £4 (British pounds). Because $20 and £;4 were each worth one ounce of gold, the exchange rate between dollars and pounds was $20/£4, or $5 to £1. For the gold standard to be effective it had to be backed up by the countrys willingness to buy and sell gold at the determined price. As long as countries maintain their currencies at a fixed value in terms of gold and as long as each is willing to buy and sell gold, exchange rates are fixed. If at the given exchange rate the number of U.S. citizens who want to buy things produced in Great Britain is equal to the number of British citizens who want to buy things produced in the United States, the currencies of the two countries will simply be exchanged. What if U.S. citizens suddenly decide they want to drink imported Scotch instead of domestic bourbon? If the British do not have an increased desire for U.S. goods, they would still accept U.S. dollars because they could be redeemed in gold. This gold could then be immediately turned into pounds. (Case & Fair, Principles of Economics, page 708) As long as a countrys overall of balance of payments remained in balance, no gold would enter or leave the country, and the economy would be in equilibrium. If U.S. citizens bought more form the British than the British bought from United States, however, the U.S. balance of payments would be in deficits, and the U.S. stock of gold would begin to fall. Conversely, Britain would start to accumulate gold because it would be exporting more than it spent on imports. (Case & Fair, Principles of Economics, page 707-709) Under the gold standard, gold was a big determinant of the money supply. An inflow of gold into a country caused that countrys money supply to expand, and an outflow of gold caused that countrys money supply to contract. If gold were flowing from the United States to Great Britain, the British money supply would expand and the U.S. money supply would contract. The impacts of a change in the money supply will expand money supply in Britain thus lower British interest rates and stimulate aggregate demand. As a result, aggregate output (income) and the price level in Britain will increase. Higher British prices will discourage U.S. citizens form buying British goods. At the same time, British citizens will have more income and will face relatively lower import prices, causing them to import more form the States. On the other side of the Atlantic, U.S. citizens will face a contracting domestic money supply. This will cause higher interest rates, declining aggregate demand, lower prices, and falling output (income). This will lower demand in the United States for British goods. Thus, changes in relative prices and incomes that resulted from the inflow and outflow of gold would automatically bring trade back into balance. Conclusion In free-market exchange system without any government involvement in the foreign exchange market, a depreciation of currency will be attain purely through the forces of supply and demand; in case of a fixed exchange rate system, the reduction will be agreed out by the government or central bank intervening to set the exchange rate at the new, lesser level by way of buying or selling the currency in order to make up for any extra supply or demand. From the above, we should conclude that there is no significant to a balance of payments deficit or surplus, each nations government will try to use necessary measures or policies to adjust each industry accordingly. Works Cited Hodgetts R. M., Luthans F., & Doh J. P. (2005). The Meanings and Dimensions of The Culture. International Management: Culture, Strategy and Behavior (6th ed., pp. 92-123). Hoffman, Richard C. and Preble, John F. (2004). Global franchising: Current status andfuture challenges. The Journal of Services Marketing. Vol. 18, Issue 2/3; p.101. Homes, G. S. (2002) Exploration in macroeconomics, 5e. Redding, CA: CAT Publishing Company. Retrieved October 17, 2007 Dominick Salvatore, (2003) Managerial Economics, in a Global Economy, 5th Edition, published by Pearson Prentice Hall McaGuigan, Moyer & Haris, (2004) Managerial Economics, 9th Edition, published by Prentice Hall Economic Report (2004/2005) volume 33th, by Ministry of Finance Malaysia Case & Fair, (2004), Principles of Economics, 7th Edition, published by Pearson Prentice Hall Michael P. Todato, (2000) Economic Development, 7th Edition, published by Addison Wesley Longman Ricky W. Griffin/Michael W. Pustay, (2005) International Business, 4th Edition, published by Pearson Prentice Hall John Sloman. (2004), Essentials of Economics, published by Prentice Hall Read More