REAL GDP AND MONETARY POLICY

REAL GDP AND MONETARY POLICY

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Real GDP and Monetary Policy

Question 1

From the information and presumed status of the economy, there is a high inflation rate, which has given rise to an increase in the unemployment levels in the country. Furthermore, this is also reflected in a slowdown in the gross domestic product (GDP) of the country. An expansionary approach would provide the government with a means of inducing production and more so the exports into new markets through a variety of measures[1]. The government may undertake a variety of measure such as the purchase of existing securities in the open market; reduce the interest rates and the reserve requirements for financial institutions and credit facilities. Increasing the gross domestic product accruable to the country would focus primarily on inducing exports by enabling new capital investments after the reduction of existing reserve requirements. Purchase of bonds by the government would result in an increase in the prices of bonds within the securities market and in the process contributing to a decline in interest rates.

Lower interest rates would attract new capital investments into various segments of the economy resulting in an increase in employment levels[2]. An increase in demand for goods and services due to relatively low costs of operation results in decline in unemployment levels due to new production opportunities for investors. Furthermore, the demand for the Australian currency results in increase in demand for foreign currency resulting in a favorable exchange for the Australian economy, all of which contributes to enhanced balance of trade.

Question 2

The interactions between interest rates in an economy and the components of aggregate demand (AD) namely consumption of goods and services, investments, government expenditure exports and imports can be understood to be linear[3]. The reduction of interest rates is usually driven by the need to induce demand for exports and attract capital investments into an economy with the aim of inducing increase in gross domestic product, exports, and enabling growth of employment opportunities. The purchase of securities in the market can provide the federal government with an effective means of reducing interest rates.

In essence, consumers as well as investors tend to save funds because of decline in confidence over the possibility of positive returns from various investments such as the securities market. this means a reduction in money supply as a large number of the population is unwilling to spend resulting in decline in employment levels and increase in imports given that goods produced in the economy are relatively expensive to produce under existing market conditions. On the other hand, it is important to note that lowered interest rates may not be effective in curbing a recession.

Essentially, interest rates affect all types of businesses, whereby the presence of relatively low or favorable interest rates, businesses, and individuals are able to access finance or credit at cheap rates[4]. The aim of reducing interest rates is usually to induce purchases and expenditures in the population. Low interest rates enable access to cheap credit for investors who may utilize this to undertake capital investments for production of different goods and services. Low interest rates are synonymous with reduced costs of doing business within a given economy, which are passed on directly to consumers in both local and foreign markets in the event of export of goods and services.

Bibliography

Galí, Jordi, and Mark Gertler. International Dimensions of Monetary Policy. Chicago: University of Chicago Press, 2009.

Jorda, Oscar, Moritz Schularick, and Alan M. Taylor. Financial Crises, Credit Booms, and External Imbalances 140 Years of Lessons. Cambridge, Mass: National Bureau of Economic Research, 2010.

Kannan, Prakash. Credit Conditions and Recoveries from Recessions Associated with Financial Crises. Washington, D.C.: International Monetary Fund, 2010.

Mishkin, Frederic S. Monetary Policy Strategy. Cambridge, Mass: MIT Press, 2007.

Semmler, Willi. Asset Prices, Booms and Recessions Financial Economics from a Dynamic Perspective. Berlin: Springer, 2006.

[1] Jordi Galí and Mark Gertler. International Dimensions of Monetary Policy (Chicago: University of Chicago Press, 2009) p.23.

[2] Willi Semmler, Asset Prices, Booms and Recessions Financial Economics from a Dynamic Perspective (Berlin: Springer, 2006) p. 31.

[3] Frederic S. Mishkin, Monetary Policy Strategy (Cambridge, Mass: MIT Press, 2007) p.33.

[4] Oscar Jorda, Moritz Schularick, and Alan M. Taylor. Financial Crises, Credit Booms, and External Imbalances 140 Years of Lessons (Cambridge, Mass: National Bureau of Economic Research, 2010) p.44.