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. Inflation would decrease the purchasing power of an individual's money, which would lead to more saving and less spending. (Fried) Less spending would mean less money being injected into the circular flow of our economy and would lead to economic crisis. However, many critics also use this to determine how national debt does not have a huge impact on the economy. A huge national debt has no effect on the money market.
These are designed to increase the level of AD and increase in national income. Lower taxation/higher government spending or lower interest rates will encourage more consumption. The diagram shows an increase in real GDP (economic growth) and a falling output gap. We would expect there to be a fall in unemployment. Therefore two objectives have been met.
However, both monetary and fiscal policy may be used to influence the performance of the economy in the short run. In general, expansionary monetary policy is expected to improve the economy's rate of growth of output (measured by Gross Domestic Product or GDP) in the quarters ahead; tight or contractionary monetary policy is designed to slow the economy in the future to offset inflationary pressures. Likewise, expansionary fiscal policies, tax cuts, and spending increases are normally expected to stimulate economic growth in the short run, while contractionary fiscal policy, tax increases and spending cuts tend to slow the rate of future economic expansion. Question 2 The workings of Monetary and fiscal policy The aim of all governments is to achieve and maintain economic growth and price stability. 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.
The Federal Reserve Bank and Recession Stephanie Armstrong ECO 203 George Murphy June 12, 2012 The Federal Reserve Bank The Federal Reserve Bank is the main source for all banks in the United States. The Federal Reserve Bank implements monetary policies that are necessary for the economy. In order to understand how the Federal Reserve Bank operates, you must understand the order in which it operates. Within the Federal Reserve Bank, there is a group, who is responsible for setting the monetary policy, and that group is the Federal Open Market committee. This committee plays a major role in the Federal Reserve Bank because the decisions they make are important to the functioning of the economy and monetary supply.
Complexities of the Financial System The U.S. Financial system consists of markets, policy makers, financial institutions, instruments, services and regulations that interact to assist with the flow of financial capital from savings into investments. The three main components of the financial system are the monetary system, which creates and transfers money; the financial institution, which accumulates, lends and invests savings; and the financial market, which markets and transfers financial assets. The financial system has a major impact on the economy, businesses and individuals. Therefore, it is important to maintain a strong and effective system. The ability of individuals to make wise economic decisions related to their personal financial affairs, the successful operation of businesses and the economic activities of the country is what the effectiveness and preservation of our financial system rely on.
At last, achieve aggregate demand and aggregate supply to be an ideal balance. Monetary policy is divided into two types: expansionary and tightening. Aggressive monetary policy is to stimulate aggregate demand by increasing the speed of the money supply growth. In this policy, it is easier to obtain the credit, and the interest rates will reduce. Therefore, when the aggregate demand compared with the economic production capacity is quite low, expansionary monetary policy should be taken into use appropriately.
Changes in the prime rate may affect the whole economy. For example, an increase may result in fewer consumers taking auto loans, which in turn may cause a slowdown in the automobile industry. Also, when interest rates go up it could possibly affect the casino and gambling industry too. Interest rates affect the way people spend their money. When interest rates rise, the casino industry may go down because people will not be able to spend money for leisure activities.
There are several ways in which changes in interest rates influence aggregate demand, one of the main changes are through the housing market & house prices. For example higher interest rates increase the cost of mortgages and eventually reduce the demand for most types of housing. This will slow down the growth of household wealth and put a squeeze on equity withdrawal (consumers borrowing off the back of rising house prices) which adds directly to consumer spending and can fuel inflation. Another situation where the monetary policy increases AD is through disposable incomes of mortgage payers. For example, if interest rates increase, the income of homeowners who have variable-rate mortgages will fall – leading to a decline in their effective purchasing power.
1.The rationale of the treasury in pressuring all eight large banks to accept capital injection is to take control of these banks. In addition, the treasury can appease the public by providing liquidity to the banks. 2. Lewis should accept the preferred stock from the U.S. Treasury under the CPP program. On January 16, 2009, Treasury made an additional investment in Bank of America by acquiring $20 billion in newly issued senior preferred stock under the TIP.
Before we explore how a reduction in the interest rates leads to an increase in consumption we must first define what it exactly means to consume. Mainstream economists such as Tim Harford define consumption as the spending by house holds on consumer products and services. As the interest rate decreases it leads to consequential reactions on behalf of consumers, one of these actions is an increase in the level of goods consumed. This is a result of it being cheaper to borrow money from banks and other financial institutions, this meaning purchases which have been prolonged or “put off” by consumers can now be readily purchased. This is an effect of a lower opportunity cost as the overall cost associated with borrowing has decreased and the marginal benefit of saving has increased, meaning consumers will receive more of a benefit if they purchase goods on credit based agreements opposed to saving, leading to an increase in the amount of credit transactions.