Why Monetary Policy Transmission Affects Economy Wide Interest Rates Essay

Course Description Principles of Macroeconomics deals with consumers as a whole, producers as a whole, the effects of government spending and taxation policies, and the effects of the monetary policy carried out by the Federal Reserve Bank. Macroeconomics is concerned with unemployment, inflation, and the business cycle. Text Required: Macroeconomics, Roger A. Arnold, 7th Edition, 2005 Recommended: Macroeconomics Study Guide, Roger A. Arnold, 7th

The money supply will increase as the components of AD (C+I) rise. Figure 2 illustrates the increase in money supply through showing the rightward shift of the MS curve, from MS1 to MS2. The money demand will remain the same (MD). Therefore, increasing the money supply will lower the interest rate from i1 to i2. This is partly due to the increased availability of money. More money around means it is easier to acquire and thus command lower interest rates. However, such an increase in money supply may also increase the inflation rate and possibly cause a hyperinflation if uncontrolled.

When there are problems in the United States economy, whom do the people turn to? The most obvious answer is the government. The federal government is given the responsibility of maintaining a stable economy. When the economy is not stable, like during a recession, the American people turn the government and demand that they fix whatever problem is occurring. The government can handle the economy in a recessionary period in one of two ways: expansionary fiscal policy or expansionary monetary policy. The sector of the government that handles the economy using these policies in a recession is the Federal Reserve. The best course of action to get the United States out of a recession is to use expansionary monetary policy.

Initially, Graph 1 shows the equilibrium interest rate in the economy, which is the point where money demanded equals the quantity of money (Money Market). Since raising interest rates are a contractionary monetary policy the money supply line will shift to the left (decrease) as shown in Graph 2. The leftward shift would occur because more people

Interest rates are manipulated by expanding or contracting the monetary base. This comprises of circulatory currency and reserves in

In this paper, we will be using the log-log model. The log-log model used for the demand for wealth (attuned for inflation). We will be using the M1, as a display, for demand on wealth and interest rate as the illuminating variable affecting the demand for wealth. Using the regression, we will study the hypothesis. For this paper, the hypothesis used will talk about the connection between money and the interest rate. The null hypothesis, in this case, will be the interest affecting the demand for money in the economy. The data that we will be reviewing is from October 2008 to October 2011, 3 years worth of data. This connection will give us the basic understanding of the performance of the monetary policy in US economy after the crisis.

Mr. Emanuel, in the current economic climate, the Obama administration’s course of action has been to pursue aggressive countercyclical fiscal policies designed to prevent further economic deterioration. Critics of these policies argue that:

The next step of the Fed is explained by Hall and Lieberman writing, “To prevent or address unwanted changes in aggregate expenditure, the Fed can change its interest rate target, adjusting the money supply as needed to reach it”(Hall and Lieberman). After interest rates increase there will be a decrease in autonomous consumption and planned investment, which then lowers the Aggregate Expenditure– see Diagram 1, then lowering output GDP. In this case the equilibrium income is less than the full employment.

Therefore, one of the expansionary activities conducted by the Federal Reserve is to set federal fund rate lower, which will affect credit availability, the money supply, interest rates, and security prices. That is to say, ceteris paribus, when the Federal Reserve buys securities in the open market, bank’s reserve accounts (deposit and assets) increases and when the discount rate is lowered it reduces the interest rate in the economy, thereby promoting borrowing, excessive spending by the economic agents, possibility that household, business and government will invest in fixed assets, increment in household purchasing durable goods (plant , state and local government and construction of new

The Federal Reserve went into action in response to the 2008 recession by rapidly reducing interest rates with the hopes of encouraging economic growth. The federal funds target rate was decreased to between zero and .25 percent. The results of the rate changes caused what is called “zero bound”, this reduced the effectiveness of monetary policy with the near non-existence of interest rates.

Monetary policy, ‘The government’s policy relating to the money supply, bank interest rates, and borrowing’ (Collin: 130), is another tool available to the government to control inflation. Figure 4 shows, that by increasing the interest rate (r), from r1 to r2, the supply of money (ms) is reduced from Q1

In my opinion, how effective low interests rates are to encourage consumers to borrow and spend depends on the elasticity of the demand for loans. If the demand for loans is inelastic, a sharp reduction in interest rates will only increase the loans by a small amount. Please refer to Appendix G. In this case, lowering the interest rates to 0.5% is not enough to stimulate demand. As a result, quantitative easing, another monetary policy is being utilized, as bank rates could not go any lower. Although there are other underlying factors that contribute to the high unemployment rate in the UK, it is shown that reducing bank rates is not the key to solving this problem.

By increasing or reducing the nominal interest rates, the money supply is either increased or reduced. When the rate goes up, people are not able to borrow, thus the money does not enter into circulation. But when the rates go down, people borrow in big numbers therefore increasing the money supply. So the monetary authority just needs to adjust the interest rates either upwards or downwards, and in-direct results will be reflected on the money on circulation.

The Economy is the backbone to society. There are many factors that operate in, and govern our society’s economical structure. Factors such as scarcity and choice, opportunity cost, marginal analysis, microeconomics, macroeconomics, factors of production, production possibilities, law of increasing opportunity cost, economic systems, circular flow model, money, and economic costs and profits all contribute to what is known as the economy. These properties as well as a few others, work together to influence the economy. Microeconomics and Macroeconomics are two major components. Both of these are broken down into several different components that dictate societal norms and views.

Monetary policy involves manipulating the interest rate charged by the central bank for lending money to the banking system in an economy, which influences greatly a vast number of macroeconomic variables. In the UK, the government set the policy targets, but the Bank of England and the Monetary Policy Committee (MPC) are given authority and freedom to set interest rates, which is formally once every month. Contractionary monetary policy may be used to reduce price inflation by increasing the interest rate. Because banks have to pay more to borrow from the central bank they will increase the interest rates they charge their own customers for loans to recover the increased cost. Banks will also raise interest rates to encourage people to save more in bank deposit accounts so they can reduce their own borrowing from the central bank. As interest rates rise, consumers may save more and borrow less to spend on goods and services. Firms may also reduce the amount of money they borrow to invest in new equipment. A