The Implementation of Economic Policies - Essay Example

The term ‘money’ includes paper money, coins, and checking accounts. The demand and supply of such assets determine the interest rate in an economy. The equilibrium interest rate is determined by the point where real money supply equates the real money demand. The money supply is controlled by the central bank. Real money demand is influenced by the interest rate and is positively correlated with real GDP. Influencing and changing the interest rate from the equilibrium rate results in conversions from (to) interest-bearing deposits to (from) money. This allows the government to influence money holdings by the public. Interest rates are also positively related to the price level in a country. Keeping all other factors constant, a rise (fall) in the real interest rates brings about a rise (fall) in the real GDP. Hence economic growth could be promoted through interest rates and therefore economic objectives could be achieved.

The money market shows the equilibrium interest rates while the foreign exchange market shows the exchange rate. Combining the two markets yields a money forex diagram. This model shows the equilibrium in both markets at the same time. The key linkages that emerge connect decreased interest rates with an increased money supply and a depreciated value of the currency. (Suranovic, 2010). With a depreciated value of the currency, a country’s product becomes cheaper in other countries; hence increasing exports. (Abel & Bernanke, 2010). This factor has a lot of implications in an economy, it can be used to: promote the production of goods and services, increase employment opportunities, support and expand industries, raise the income level and reduce poverty, and so on.

Over the long haul, an increase in the supply of money causes price levels to rise which brings about inflation. Incorporating the role of unemployment in this phenomenon yields magnified results on the price levels and hence the rate of inflation. By limiting the increase in the supply of money to affect the price levels, governments can stop the adverse effects from hampering economic growth and impeding the achievement of economic objectives.

In addition to purely interest rate created influence to direct the economy, fiscal policies are also used. It involves the usage of government expenditures and revenues (tax collection) to influence the economy in three basic ways: re-allocation of resources, change in aggregate demand and the overall economic activity, and the distribution of income.