Banks have a reserve requirement, which is set by the fed. A reserve requirement is the minimum percentage of a bank’s total reserves that they are required to keep, for security reasons. (Schiller) The fed can change the reserve requirement to allow a bank to loan more/less money, which is used to control the economy. Many critics use this to determine that annual deficit spending has a negative impact on the economic stability of our country. The fed has to set a lower reserve requirement, which allows banks to loan out more money, which generates more interest, which could lead to periods of inflation and could have worse consequences if the government does not react quickly enough.
1. Explain how open market operation determine the cash rate Open market operations (OMO) involve the purchasing and selling of government bonds in the short term money market (STMM). This affects the cash rate by changing the amount of currency available in the STMM, and as the cash rate is in reality the interest rate in the STMM, by influencing the amount of currency, through the factors of supply and demand the cash rate is then changed. This can be seen in the situation where the RBA purchases many government bonds in the OMO, thus releasing a large supply of currency into the market. Due to excess supply, demand for currency falls and there is a corresponding decrease in the interest rates in the STMM.
However, when the economy is in an inflationary situation, there is the need to implement policies to reverse this trend; these policies are referred to as contractionary fiscal policies. This article seeks to highlight the workings of Monetary and Fiscal policies. Contractionary Policy Effects • Contractionary policy is any government policy aimed at reducing aggregate output (Y). • Why would the government want to reduce Y? One purpose is to
The effects of a fall in consumer wealth will be to reduce confidence and consumer spending; equity withdrawal will slow down sharply – this has been a significant contributor to increasing AD in UK). Therefore, falling house prices will cause a fall in AD and is likely to cause a recession. This occurred in 1991 and 1992 when falling house prices caused a recession 2. Reduce House Price Volatility To prevent a house price crash, in the future, the government needs to reduce house price volatility and speculation. For example, the government could try these policies Encourage Fixed Rate Mortgages – Makes mortgages less sensitive to interest rate changes.
Should the government allow the peso to fall even farther to stimulate exports? Why or why not? The fall in the value of the peso led to hyperinflation and bank collapses, adversely affecting business ventures for companies in Argentina. As a direct result, trust in the peso diminished and companies invested in the US dollar because of its widely trade availability. It is not surprise that
For consumers, interest rates represent the available funds they are willing to borrow to satisfy today’s needs. For businesses they represent the cost of borrowing money to invest in the growth of a company. Interest rates affect the economy. As the Fed raises or lowers short-term interest rates, banks may raise or lower the interest rates they charge borrowers, including the prime rate (Northrop Grumman, 2009). Changes in the prime rate may affect the whole economy.
Evaluate the effectiveness of demand-side policies to reduce inflation Plan: * Define demand-side policies and inflation * Differentiate between fiscal policy and monetary policy * How they can be used to reduce inflation – changing tax, government expenditure, changing money supply and altering i/r and exchange rates * Explain the benefits / downsides of using demand-side policies against using supply side measures and physical policies Demand side measures, or demand management, are policies used to reduce inflation by altering aggregate demand and are usually associated with Keynesian economics. Inflation is the persistent or continuous rise in the general price level or a fall in the value or purchasing power of money. It is usually measured using a consumer price index. Demand-side policies can be divided into two different types of policies; fiscal policy and monetary policy. Fiscal policy concerns the use of changes in the amount of taxation (T) and government spending (G) to influence the national economy.
The impact of the opinions can lead to changes within government and how to deal with further occurrences of major political or economic upsets. Macroeconomics might be about the economy abroad, but it has the tiniest effect on even the smallest part of our lives. To further explain macroeconomics, look at all the potential factors of change. With this known, the pricing of stocks, government bonds, and corporate bonds are affected by the release dates of the consumer price index (CPI), unemployment rate, nonfarm payroll, and the federal funds rate (Brenner, Paquariello, and Subrahmanyam 1266). These have major effects on how companies will respond to the effects by the price of their goods, and the availability of these goods.
The Components for Aggregate Demand are C (consumption)+ I (income)+ G (government spending)+ (X-M) (net exports) and a change in the components of Aggregate demand will cause a shift of the curve. Fiscal policy is a type of economical intervention where the government injects its policies into an economy in order to either expand the economy’s growth or to contract it. By changing the levels of spending and taxation, a government can directly or indirectly affect the aggregate demand. Fiscal policy can be used in order to either stimulate a sluggish economy or to slow down an economy that is growing at a rate that is getting out of control. There are two types of Fiscal policy put in place to alter the level of aggregate demand; Expansionary fiscal policy and Contractionary fiscal policy.
During this period, many economies moved away from use of the gold standard and adopted monetary systems that required a new economic theory to guide policy makers in dealing with economic activities within an expanding and more complex economic environment. Keynes developed and published his economic theories during the Great Depression. In his paper The General Theory of Employment, Interest, and Money (1936), Keynes argued that aggregate demand was innately unstable because people made investment decisions based on the unpredictable “animal spirits” of business expectations. Keynes proposed that if people developed pessimistic expectations about the economic environment, they would pull back on investment activities which in turn would result in a reduction of aggregate demand, output, and employment. When Keynes spoke of investment he was not referring to investments such as those in the stock market, but to investment in the production of goods and services.