...INFLUENCE INTEREST RATE IN UNITED STATES INTRODUCTION Issues of interest rate are of major concern to every citizen in United States and often call for long debate and discussions among economists and other specialists . Generally, interest rate is defined as the rate which is charged or paid for the use of money. In other words, the cost for the use of money is called interest rate. Interest rate can be stated as real or nominal. Real rate of interest excludes inflation but nominal interest rate includes the effect of inflation. Factors influencing interest rate could be discussed differently from various field of study such as finance and accounting. However, this paper seeks to discussed, theoretically, only the major economic factors influencing interest rate in US. SCOPE There are four major factors that are found to influence the rate of interest in United States. These factors are the Federal Reserve policy, budget deficits or surplus, business level activity and international trade deficit or surplus. 1. Federal Reserve policy In United States, the Federal Reserve Board controls the money supply. The money supply has a major effect on both the level of economic activity and the inflation rate. If the Fed wants to stimulate the economy, it increases growth in the money supply. The initial effect is to cause interest rates to decline but a larger supply of money may lead to an increase in expected inflation which will push interest rate up. If the Fed eases credit, interest...
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...Given the severity of this recession characterized by high unemployment and low inflationary rates I believe that a two sided approach is necessary utilizing both expansionary monetary and fiscal policy would be the most appropriate remedy as proposed by Allison Tanney. Under Fiscal Policy: I would reduce taxation which will encourage businesses to expand and in so doing create employment. The reduction in taxation will also positively affect the disposable income of consumers thus causing total aggregate demand to increase. This is the opposite of what Kathy lee was proposing her proposal would remove money from the economy which would have a negative effect on businesses making it difficult for business expansion. These two strategies are inflationary however due to the current negative rate of inflation there should be very little to no concern as it relates to its impact on inflation in the short term. The government should also increase spending in the form of subsides and incentives for the creation of new businesses or to existing businesses who are expanding and thus creating extra employment in the economy. This was proposed by Allison Tanney and I totally agree with her. Under Monetary Policy: Under Monetary policy the president may want to consider requesting or lobbying the fed to engage in one or a combination of these strategies. In open market operations the fed should purchase securities (bonds) in the open market thus increasing the supply of money in...
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...Federal Reserve: Current Policy and Conditions Summary The Federal Reserve (the Fed) defines monetary policy as its actions to influence the availability and cost of money and credit. Because the expectations of market participants play an important role in determining prices and economic growth, monetary policy can also be defined to include the directives, policies, statements, and actions of the Fed that influence future perceptions. Traditionally, the Fed has implemented monetary policy primarily through open market operations involving the purchase and sale of U.S. Treasury securities. The Fed traditionally conducts open market operations by setting a target for the federal funds rate, the rate at which banks borrow and lend reserves on an overnight basis. Beginning in September 2007, in a series of 10 moves, the federal funds target was reduced from 5.25% to a range of 0% to 0.25% on December 16, 2008, where it has remained since. With the federal funds target at this zero lower bound, the Fed attempted to provide additional stimulus through unconventional policies. It provided forward guidance on its expectations for future rates, announcing that it “anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” The Fed also added monetary stimulus through unsterilized purchases of Treasury and mortgage-backed...
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...it in a demand deposit, by how much may the deposit expand the total money supply? Assume that the legal reserve requirement (required reserves ratio) is 20%. What is the effect of raising the legal reserve requirement to 50%? Since multiplier effect needs to be considered, the total increase in money supply at $10,000 would equal to $50,000 = [$10,000x(1/20%)=$50,000]. If the legal reserve requirement is increased to 50%, the total money supply would expand by only $20,000 = [10,000x(1/50%)=20,000]. From this example we can conclude that the lower the reserve requirement the higher the total expansion of money supply. 2. Describe how Open Market Operations can be used in an expansionary monetary policy. Fed could use Open Market Operations in order to achieve lower target for federal funds rate by buying bonds from banks and public. Purchase of bonds increases the reserves in the banking system, which in turn aids expansion of economy. 3. What happens to the money supply if the FED raises the discount rate? Describe the effect on the banking system and on the money supply. (2 pts) The Fed raises discount rate when it wants to discourage commercial banks from borrowing the money. By doing so the Fed hinders the ability of banks to get additional reserves and lend to businesses or public. The Fed usually does this when they want to restrict the money supply to prevent rapid rise of inflation or other economic perils. 4.Consider a full employment economy where...
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...that our economy is kept under control. Both policies have their strengths and weaknesses, some situations favoring use of both policies, but most of the time, only one is necessary. Fiscal Policy can be explained in many ways, for example. Fiscal policy is the use of the government budget to affect an economy. When the government decides on the taxes that it collects, the transfer payments it gives out, or the goods and services that it purchases, it is engaging in fiscal policy. The primary economic impact of any change in the government budget is felt by particular groups make tax cut for families with children, for example, raises the disposable income of such families. Discussions of fiscal policy, however, usually focus on the effect of changes in the government budget on the overall economy on such macroeconomic variables as GNP and unemployment and inflation. Fiscal Policy also can be explained as the economic term which describes the behavior of governments in raising money to fund current spending and investment for collective social purposes and for transfer payments to citizens and residents of the territory for which the government is responsible. The money may be raised by taxation, by borrowing, by user charges on social assets or services, or by fiat. Fiscal policy can include deficit spending to stimulate demand for domestic goods and services to help unemployment or make efforts to cut deficits or raise the budget surplus to fight inflation. There...
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...The purpose of the Fed is to control the United States economy by implementing policies to regulate interest rates and the money supply. To understand better how the Fed system works, we have to understand the purpose of money and its function, and explained how the central bank manages the monetary system. Summarize the stated direction of recent monetary policy to realize why the fed makes such decisions as well as list at least one policy that the Fed took to confirm that direction, and as a final point explain the impact of monetary policies on economic production and employment. “Money is the set of assets in the economy that people use to buy goods and services from other people” (Mankiw,). Money includes currency, paper bills, coins, and any of those accepted by sellers in exchange of goods or services. Money has three main functions. The first function is as medium of exchange, buyer use money in exchange for goods or services. Second, money as a unit of account, people use it to post prices and record debts. Finally, money as a store of value, people can use money to transfer purchasing power from the present to the future. Money is administered by the government through the Federal Reserve who acts as the central bank of the nation’s monetary system. The central bank is an institution designed to supervise the banking system, and regulates the quantity of money in the economy. In the United States, the Fed is an example of a central bank. The Fed has two main purposes...
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...the booms and busts of the business cycle. b. the economy would stabilize itself too quickly without government intervention. c. there are significant lags due to the nature of the political process. d. All of the above are correct. ANSWER: a there is no reason for society to suffer through the booms and busts of the business cycle. SECTION: 1 OBJECTIVE: 1 2. The Federal Reserve will tend to tighten monetary policy when a. interest rates are rising too rapidly. b. it thinks the unemployment rate is too high. c. the growth rate of real GDP is quite sluggish. d. it thinks inflation is too high today, or will become too high in the future. ANSWER: d it thinks inflation is too high today, or will become too high in the future. SECTION: 1 OBJECTIVE: 1 3. If the Federal Reserve loosened monetary policy today because it believed a recession was going to hit the economy in about one year, this is an indication that the Fed a. is undertaking an inappropriate monetary policy. b. recognizes the problem of lags. c. recognizes the fact that money is neutral. d. is conducting a procyclical monetary policy. ANSWER: b recognizes the problem of lags. SECTION: 1 OBJECTIVE: 1 4. When economists say that there is a time lag in the effect of monetary policy, they mean that a. it takes time to observe the effects of fiscal policy on the economy. b. the Fed takes awhile to figure out...
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... 5. Conclusion 15 6. Reference List 16 1.0 Introduction In macroeconomics, monetary policy is an importance tool to Central Bank and is a policy set by the members of Central Bank. It is an economic strategy chosen by government that authorizes Central Bank to regulate and influence the economic activity by controlling the monetary base flow into national economy. The goals of monetary policy are to promote growth of the economy, stability of prices and reduce unemployment rate. Monetary policy can be classified into two categories, namely expansionary monetary policy and contractionary monetary policy. Although, the objective for the two policies is the same, they adopt different approaches in reaching this objective. Expansionary monetary policy is used when a country is facing a recession in the economy business cycle, whereby it increases the money supply in economy system to meet its objectives. In contrast, where there is a peak in the economy business cycle, central bank will use contractionary monetary policy to reduce the money supply in economy system so as to retard the inflation. For example, the United States, one of the top ten richest countries in the world (IMF, 2011, pp.1), had entered into a recession seen the global financial crisis and faced a slow...
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...learn about economic interactions between households, business, and government. They study gross domestic product and the effect inflation and unemployment has on the aggregate economy. Students add to their vocabularies terms, such as Keynesian, money wealth effect, and the principle of increasing marginal opportunity. They ponder issues, such as if a country is operating inefficiently and hence is at a point inside the production possibility curve because its lawns produce no crops, but occupy more land than any single crop, such as corn. In addition, students discover that AS/AD is an economic model, not a hard rock band. This week, rates of interest, the United States’ monetary policies, and the Multiplier Model are topics students have an opportunity to explore. Rates of Interest In the world of economic studies, the term, interest rates, inevitably comes up. Interest rates are key factors within the financial sector. Economists define interest rates as the process charged for the use of financial assets. Interest rates fluctuate almost daily. The largest contributing factor is the current economy of the country. When the economy is growing, people are getting more employment, and more saving and lending occurs. Interest rates tend to increase as the demand for money increases. The opposite holds true when the demand for money falls. As the demand falls, interest rates will fall. Another factor that affects interest rates is acts of the government. The federal government is...
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...Expansionary monetary policy is an increase in the quantity of money in circulation, with corresponding reductions in interest rates. This policy is put in place in order to stimulate the economy and correct or prevent a contraction. It is also used to address the problem of unemployment. It is a policy used by monetary authorities to expand money supply and boost economic activity, mainly by keeping interest rates low to encourage borrowing by companies, individuals and banks. An important effect of expansionary monetary policy is control of interest rates. As the quantity of money increases, banks are willing to make loans at lower interest rates. Contractionary monetary policy is the opposite of expansionary monetary policy. It consists of selling U.S. Treasury securities through open market operations. In addition, it also involves raising the discount rate, and increasing reserve requirements. The resulting decrease in the money supply and increase in interest rates decreases aggregate expenditures and aggregate production, and reduces inflationary pressures. Contractionary monetary policy results in a decrease in the quantity of money in circulation, with corresponding increases in interest rates, in order to halt a business cycle expansion and address the problem of inflation. An effect of contractionary monetary policy is control of interest rates. As the quantity of money decreases, banks...
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...Running head: MACROECONOMIC IMPACT ON BUSINESS OPERATIONS Macroeconomic Impact on Business Operations Laurie Wilkinson University of Phoenix Macroeconomic Impact on Business Operations The Federal Reserve has the unique ability to control the money supply and stimulate the economy when needed. Any actions of the Federal Reserve can have an impact on macroeconomic factors and the balance in the economy. This paper will discuss the tools used to control the money supply, the effects of monetary policy on macroeconomic factors and the best way to achieve a balance in the combinations of monetary policy. The Federal Reserve has several tools available in order to control the money supply. The Reserve Ratio allows the Fed to raise or lower this ratio to affect the amount of money and ability a bank has to lend. The Open Market Operations is also available, where the Fed can buy or sell government bonds to the public and commercial banks. Depending on which they do this action can either increase the assets on hand or increase the reserves for the banks. Increasing the reserves allows banks to lend more. Finally, the Discount Rate is available to use. The Fed can make short term loans to banks, increasing the amount that the bank can lend out which in turn increases the money supply. If the bank increases the discount rate then banks will not want to borrow as much and it restricts the amount of money they have to lend. Monetary Policy can be looked at as a way the Federal Reserve...
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...well be the answer. The first topic of discussion is Expansionary Fiscal Policy and how the government uses the policy to affect the economy. Expansionary Fiscal Policy is a type of policy which includes increase in government purchases, a supple decline in taxes, while making an increase in transfer payments. These changes are designed to close the recessionary gap, while increasing economic stimulus packages and they aim to decrease unemployment. The government will introduce Expansionary Fiscal Policy during anticipation of contractions in the business-cycle. Increase in government spending will increase aggregate demand, and aggregate expenditures. The down side to Expansionary Fiscal Policy leads to budget deficits, and will leave the government with smaller surpluses. The idea of changing taxes and government spending during a recession must be compensated by a surplus during booms. “The goal is to keep tax rates stable and allow the deficit to fluctuate over the cycle. It would be a...
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...turn around and hires more employees. Another benefit of tax cuts would be increased capital expenditures spending. A jobs bill would be directly aimed at creating jobs in the small business sector. The goal would be to increase the availability of credit for all small businesses. The creation of jobs bill would be aimed at increasing SBA lending and lowering capital gains taxes, which would encourage entrepreneurship and investments. Funds disseminated to local governments have the greatest multiplier effect. By getting funds to these governments, it would allow states to stop raising taxes on residents and from cutting needed services, which would help lower the unemployment rate and not further punish overly-taxed residents. In order to contract the economy, Congress and the President cut spending and program to cool the economy. If done correctly, the reward is an ideal economic growth rate of around 2-3% a year. “That means fewer contracts going to government contractors and employees, and less money in taxpayers' pockets. Benefits paid through entitlement programs are not changed by discretionary fiscal policy, except through an Act of Congress.” (Amadeo) What does the Federal Reserve do to stimulate the economy? What does the Federal Reserve do to contract the economy? The Fed...
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...far-reaching effects of monetary policy by choosing one action the U.S. Federal Reserve (the Fed) has taken in the past 10 years and explaining its effects. * What action did the Fed take? When did this happen (month/year)? * How did this action affect interest rates and exchange rates? * How were banks and businesses affected? * What was the impact on international trade? * Do you believe U.S. monetary policy should follow Keynesianism or Monetarism? Explain your reasoning. Be sure to cite all references using APA style. The three central bankers named in the list of most powerful men are influential because they handle the monetary policy. Monetary policy is a powerful and immediate tool to affect the demand side economics of any country. Monetary policy operations have far reaching effects which are much more immediate then fiscal policy. This also renders monetary actions a bit dangerous as at least five of the eight post war recessions in US can be attributed to anti inflationary policies of FED. (Tobin, 2008, ret: www.econlib.org). So the power that resides in central bankers hands in enormous. Lets take the example of Global Depression that started in 2008 and was caused by Mortgage backed Securities in USA. To remedy this situation FED took many actions like Expansion of Fed Balance Sheet, Agency Mortgage-Backed Securities (MBS) Purchase Program and Dollar Swap Lines. Let us focus on the open market operations where FED bought these...
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...Running head: Monetary Policy and Its’ Effect on Macroeconomic Factors Monetary Policy and Its’ Effect on Macroeconomic Factors Edward Thaxton University of Phoenix MMPBL/501 Forces Influencing Business in the 21st Century Dr. Sangeeta Bishop March 8, 2010 Abstract This paper will illustrate the affects of The Fed, the creation of money and the monetary policy. The monetary policy has a direct impact upon aggregate demand, gross domestic product, unemployment, inflation, and interest rates. Monetary Policy and Its’ Effect on Macroeconomic Factors In earlier times traders used gold for transactions, and realized that it was inconvenient so they began to make deposits with goldsmiths. The goldsmiths provided the depositor a receipt for the value of their deposit of gold and people began to use the receipts as payments. The goldsmiths backed their receipts fully with the gold that they held in their vaults. These receipts were used as the first kind of paper money. Today, gold is no longer used as bank reserves. This was the beginning of the fractional reserve system of banking, in which reserves in bank vaults are a fraction of the total money supply. The creation of checkable deposit money by banks, limited...
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