How does the increase in supply of money affect the ratio of interest rates and inflation?
The theory quantity of money states that for normal growth to take place, there has to be a certain amount of money in circulation so it can facilitate growth. If the money is increased devoid of proportionate growth increase, the price of products increases as the population would then have more money (demand) than products in supply. This leads to inflation. Generally, whenever there is increase in supply of money, value of money is reduced though there is increase in money available in banks for lending to consumers. The increased money in banks leads to low interest rates banks charge to consumers. This leads to increased borrowing which also increases the spending by consumers. The pattern of spending affects aggregate demand for products and also leads to aggregate increase in the price levels that lead to inflation.
How does the increase in price level affect aggregate quantity of services and goods demanded?
An increase in price of commodities leads to a huge change in the quantity demanded. The demand aggregate curve indicates as the commodities price increawes, the demanded quantity decreases. This is due to nominal money value which is considered as fixed but the actual value of money depends on price level. This being the case, low prices indicates a higher purchasing power per unit of currency. If the commodity price increases and currency value remains the same, disposable income decrease as well making it easy to buy only a few items.
Do politicians have ability of instituting policies that concurrently increase inflation and decrease unemployment?
Some policies instituted by politicians are aimed at steering economic growth for a term that is temporary. With this as the case, some of the policies might be applied by members of parliament or congress in favor of local citizens in the short run. For instance, parliament might raise commodities taxes in order to meet some huge deficit budget through taxation. The effect this has is increase in product prices that are consumed by citizens. Increase in product prices without any proportionate increase in the monetary value leas to value of money purchasing lesser quantities of the same product and this leads to inflation. Since manufacturers of services and good might not be able to sustain inflation effects, they have the tendency of laying workers off leading to cases of unemployment.
Whenever politicians, on the other hand pass policies aimed at employment reduction, they lead to inflation. The Phillips curve explains this where government lowers interest rates and this leads to money surplus within the economy. There is also rise in expenditure levels that lead to overall increase in price levels. This leads to cases of reduced unemployment since most of those unemployed will be in a position to seek. Therefore, this is an indication that policies made by politicians have the capability of increasing inflation and decreasing unemployment.
How does increase in federal funds rate affect aggregate demand, real GDP, and price level?
When federal fund rates are increased, the interest rate in the market is affected. This is due to increase in interest rate that leads to increase in interest on loans commercial banks pay while borrowing or repaying from federal bank. With this being the case, banks will reciprocate the same to business men through charging high interest rates on borrowing. Businessmen tend to borrow less but with interest rates that are high leading to reduction in investment as such affecting aggregate demand (McEachern 320). The final consumer also gets affected in the sense there will be investments that are fewer by businessmen which leads to increase in product prices. The entire process therefore affects aggregate demand of products in the market.
When federal funds rate increase, there is also reduced attractiveness of holding money and this in turn leads to reduction of money demanded hence slowing growth of money in stock. The amount of money sought over certain duration would equal the GDP after a specific period. Since GDP is the broadest measure of economic activity in any country and it offers a general direction of aggregate economic activities if there is any increase in rate of federal funds then it is likely there will be reduction in economic activities as a result of the rise in aggregate effect of federal funds rate. This therefore leads to slow performance in economy leading to a low GDP within the country.
Increase in rate of federal funds also affects price levels. Whenever federal funds are increased, ripple effects caused forced commercial banks to raise lending rates as they have to reciprocate federal bank increase effects to lower beneficiaries. Producers increase cost of production since interest in borrowing is high. This leads to increase in overall prices.
Discuss the advantages and disadvantages of fixed versus flexible exchange rates
Any given currency’s price is determined in 2 ways. One of these is the fixed rate in which case the government or central bank sets and maintains official exchange rates. In this instance, the set price is determined against major world currencies such as the yen, euro and other numerous currencies. Therefore, the central bank sells its currency in return for currencies it has pegged. Flexible rate of floating rate on the other hand is the rate determined by market forced and supply. Usually, this rate is self correcting though the central bank might intervene in order to enhance the currency’s stability if it considers the trend of exchange as flexible and this can cause unstableness or inflation. Some of the disadvantages and advantages of flexible and fixed rates include the following:
Fixed exchange rates
- It offers a string incentive and stability for control of speculation and inflation.
- Fixed exchange rates aid in prevention of currency fluctuations. Since there is significant fluctuation of currency, it impacts greatly on firms in the economy, fixed exchange rates of any currency also impact greatly on the firms in the economy and they help these firms run efficiently regardless of fluctuation. This aids in reduction of devaluation of currency, balances export and import trading.
- Fixed exchange rates also have the advantage of reducing uncertainties for economic agents that operate in an economy. This is due to the government which sets exchange rates based on global performance rate.
For a fixed exchange rate level to be kept, there are conflicts that occur with other macroeconomic objectives.
- The flexibility is less as one might not be in the position of responding to temporary shocks.
- There might be current account imbalances as a result of devaluation or over valuation of rates of exchange.
Floating Exchange Rate
- There is no need in keeping high reserve levels as the exchange rate adjusts itself so as the keep the account balanced.
- With exchange rates that are floating, there is no need for intervention by the central bank as market forces adjust themselves in response to global exchange rate changes.
- There are low foreign exchange reserves and crisis is reduced die to automatic changes that provide freedom.
- The vitality rates for floating exchange rates are high and uncertainty in trading since the sellers are not certain of what they can get from trading.
- Speculation destabilizes and destroys the economy and often leads to cases of inflation as the trades increase prices due to the uncertainty.
- Existing problems are worsened by floating exchange rates.
- It might also lead to lack of investment as a result of uncertainty involved.
On the basis of the discussion regarding floating and fixed exchange rates, the determinant regarding which is better is dependable on rates applicability. There are situations where fixed rates are considered better for a country and especially if it needs to force it to the prudent and better monetary policy course. On the other hand, floating exchange rates are better when prudent domestic policies are put into place. But due to market uncertainty, the flexible/floating exchange rate system is considered better because of its autonomy over monetary policies and it can also be used in guidance of national economy especially if the economy is not stable.
McEachern, William A. Economics: A contemporary introduction. CengageBrain. com, 2011.