National Economic Policies

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National Economic Policies

1. It is paramount to maintain a fixed rate of interest rates because an increase in interest rates is bound to increase the rate borrowers repay their loans, which might send the various market segments into a shock. Increase in output leads to lower prices in the market for the various products as people use price tactics to attract consumers or buyers. Fixed exchange rate polices would be sufficient to enable market players to exercise sufficient control and freedom within the market. This comes in the form of the ability of the players to export more products hence increasing the foreign exchange reserves of the country (Blanchard, 1997).

The largest component of the GDP is consumption as it revolves around purchase of the produced gods. It is influenced by the current rates in any market due to its presence. In addition, the presence of affixed exchange rate enables the government to have adequate resources to fund its expenditure to the presence of foreign reserves, which can be used to fund the government expenditures. Increase in public expenditure results in a necessity by the government to increase interest rates to curb inflation and source for more funds to maintain the expenditure (Blanchard, 1997). Exports and imports are directly affected by the fixed exchange rates in that an increase in exports makes it easier for the exporters to sell their goods because of the presence of adequate foreign reserves. In addition, the presence of adequate reserves enables the country to make adequate imports without any negative effects.

This results in an increase in the incomes. This is because of an increase in the output by the manufactures or market players within a specific demographic region. The policymakers keep the rate(r) constant. However changes in the monetary policy results in the shift illustrated by the move of the LM1 to LM2.

2.Income elasticity of money demand refers to the rate of response of quantity of money demanded owing to increases or decreases in the money income by the public whereas the interest of money elasticity of money demand refers to interest rate for borrowing funds from financial institutions or other potential borrowers (Mankiw, 2000).

The use expansionary fiscal policies are often in a liquidity trap such as an increase in government expenditure and lowering of taxes by the government in efforts to increase growth brought about by the aggregate demand attributed to increase in costs.

Diagram of the crowding effect (A) Effects of expansionary of fiscal policies (B)

As illustrated by the diagram decrease in the taxation rates increases the disposable income of individuals leading to higher consumer spending as evidenced by the lines IS1 to IS2 while maintaining the factor LM constant. However, the move might lead to inflation due to the presence of excess liquidity within the markets. This in turn leads to an increase in the deficits in the government coffers hence it becomes unable to fund its expenditure leading to an increase in taxes (Mankiw, 2000). This might lead to the crowding effect whereby there is an increase in the interest rates due to an increase in public expenditure. The second diagram illustrates a shift from AD1 to AD2, whereby the AD one is in crowed scene or Keynesian situation whereby there is crowding in terms of the funds available in market due to the presence of a lot of liquidity in the market. Hence the shift is necessitated by the change in polices and AS, as depicted by the slope which indicates supply(S).

3. Increase in government spending has a larger effect because it creates deficits within the government coffers because of increase in debt, which was sought to finance the spending. In a closed economy model, the company is forced to negotiate inertest rates as well as exchange rates hence creating a level of uncertainty within the markets. Thus, the use of the fixed exchange rates is preferred because it creates a level of certainty within the markets and is able to counter the effects of interest rates, which are brought about, by uncertainty and inflation within the markets. Perfect capital mobility is the presence of no barriers in the exchange and trade of currencies brought about the presence of a fixed exchange rate in the market (Blanchard, 1997).

Fixed rates for countries with large exports accrue numerous benefits because the country has the ability to retain large amounts of foreign reserves. However, of the country imports more than it was exporting the country is left with inadequate foreign exchange or a deficit within the foreign exchange because much of the funds are used in the purchase of imports for consumption (Blanchard, 1997). The diagram below is an illustration of an increase in government spending, which increases the interest rates, IS. The shift of IS1 to IS2 shows an increase in the interest rates while maintaining the same monetary policies. The Y1 depicts the first year when the monetary polices are held constant with respect to the interest rates. The second period, which is coupled by an increase in the rates, shows the increase and thus the difference or shift in the levels of interest.

References

Blanchard, O. (1997). Macroeconomics. UpperSaddleRiver, NJ: Prentice Hall.

Mankiw, N. G. (2000). Macroeconomics. New York, NY: Worth Publishers.