(Exhibit 2.7) At interest rate above i, there is a surplus of loanable funds. At interest rate below i, there is a shortage of loanable funds. When a disequilibrium situation exists, market forces should cause an adjustment in interest rates until equilibrium is achieved. If the prevailing interest rat is blow i, there will be a shortage of loanable funds. The shortage of funds will cause the interest rate to increase, resulting in two reactions: 1.
This will increase interest rates because the trade deficit will demand loans from the foreign countries. Problems 6-2: 2.25% 6-3 6-4: 1.5% 6-5 Integrated Case a. The four most fundamental factors are inflation, risk, production opportunities, and time preferences for consumption. b. The real risk free rate of interest is the rate that would exist on default free securities in the absence of inflation, and the nominal risk free rate is the risk free rate plus an inflation premium.
As the Reserve increases interest rates, it effectively lowers the demand for money. Increasing the interest rates would be in the Reserves best interest when the nation is experiencing rising inflation. This type of monetary policy is called contractionary monetary policy (Hubbart, 869). On the other hand, to increase demand for money the Reserve can decrease the interest rate. Decreasing the interest rate effectively increases consumer and businesses consumption.
When the demand for U.S. dollars increases, the value of the dollar will increase or appreciate (Stone 2008, pp. 685). As a result, U.S. products become more expensive for foriegners causing a reduction in exports and increasing imports. This not only effects the U.S. economy, but also affects the economies in other countries. Monetary policies influence and are influenced by international developments, including exchange rates, and based on these market conditions the U.S. government can make strategic changes to these policies to maintain the country’s economic stability (full employment, stable growth and price stability).
However, pensioners will be hit hard because the extra income they earn from saving will have dramatically reduced, making them worse off. On the other hand, savers may leave the pound for better interest rates in other countries (hot money), causing a fall in the demand for the pound. As a result the value of the pound will fall, making exports cheaper and there will be an injection of net exports. In conclusion, the impact of loose monetary policy will be beneficial to the economy because extra consumption and investment will cause AD to increase which will increase economic growth. However, it takes a long time for changes in interest rates to feed through to consumption and investment and by then the economy may have gotten worse.
▪ Consumers might expect prices to fall further and cut back consumption now. 12. When interest rates rise, people are: ▪ More likely to borrow, that is, purchase a financial asset. ▪ More likely to borrow, that is, sell a financial asset. ▪ Less likely to borrow, that is, sell a financial asset.
So each country has different currency, for example country A currency is 2 bills to our United States currency B which equals a dollar. So if we trade with country A we would get more for our dollar then country A would get less for their currency. The factor of inflation is a country that has consistently lower purchasing power like country A. This can cause higher interest rates for that country. Another influence is what they hold in a current account could be considered a deficit which means the country is spending more on foreign trade than it is receiving.
The Federal Reserve can prevent inflation by changing the interest rates on money that banks and business borrow. If it looks like the economy is likely to inflate, the Federal Reserve will raise interest rates. This reduces growth in money, making it more expensive for banks and businesses to borrow. Banks and businesses cannot expand if they can’t borrow. The less expansion, the less inflation.
Many economists believe “that a rapid stock of the nation’s money causes inflation” (pg.169). The rate of inflation can affect borrowing power for a new business owner as, “the rate of inflation expected by the borrower and the lender will be influence by various interest rates” (pg. 169). When inflation is high, many lenders interest rate increase to compensate for the impact inflation has on their business and the decrease in purchasing power of money that has to be paid back in the future. Since, the FED set the interest rate in which the banks borrow from, Edgars’ ability to borrow enough money or establish a line of credit to start his business will be affected by inflation, interest rate and financial policies.
At the same time, there are increasing concerns about the fact that concentration in the financial system has increased; big banks may feel less competitive pressure to lend – despite the fact that they are highly profitable. The “Too Big to Fail” bailout of our big banks will have the most resounding effect on economic future. The latest quarterly report from the Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program (TARP), is the best official articulation yet of why Too Big To Fail is here to stay in the United States – and we are likely on the path to these institutions (Johnson & Kurtz, 2011) becoming Too Big To Save. There are moral hazard and potentially dire consequences associated with the continued presence of financial institutions that are deemed ‘too big to