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Assignment 13

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Assignment 13

Introduction

At any given point, there is the total amount of money that circulates in a country. This amount is referred to as the supply of money. In order to achieve a certain level of economic growth, it is necessary to control the supply of money in the country. This process undertaken by the monetary authority of the country is referred to as the monetary policy. The goal of the monetary policy is either to increase or decrease the total amount of money circulating in the economy. This paper examines various aspects of the monetary policies of giving economies.

How FED Can Increase Money Supply through Open Market Operation

The system of central banking in the United States of America is known as the Federal reserve system or simply as the Federal reserved. Informally, it is referred to as the FED. The main role of the FED is the monetary policy with the aim of stabilizing prices, maximizing employment, and moderating interest rates in the long-run period.

One of the methods applied by the FED in the monetary policy is the open market operations (OMO). The OMO involves the selling and buying of the Federal government securities. This process is usually an open process where the forces of the market are allowed to play. When there is excess money circulating in the economy, the FED sells the securities to various dealers. It makes the excess money to go back to the government reserves. In case there is a shortage of money circulating in the economy, the FED buys back the securities from the dealers using the money reserves. It makes sure that the only sufficient amount of money circulates in the economy.

How FED Can Increase Money Supply through the Discount Rate

The discounting process involves the payment periods by the debtors. In this case, a debtor may buy the rights to postpone or to delay the payment. The party that is supposed to make payments on the current date may pay more in order to get rights to pay for a future predetermined date. The discount rate is the yield that is obtained when these rights are purchased. The FED could apply this method to increase the money supply. It can do so by decreasing the discount rate so as to encourage its debtors to delay in returning the money to the money reserve. In this case, the assumption is that the debtors are the general population in the USA.

How FED Can Increase Money Supply through the Reserve Requirement

The requires all commercial banks in the United States of America to deposit a certain amount of money to the general reserves. The amount to be deposited is usually predetermined and fixed by the FED. To increase money supply in the economy, the FED will require to decrease the reserve requirement for the commercial banks. It will leave the commercial banks with more money for withdrawing by the customers (general population) in the economy.

How a Liquidity Trap Reduces Monetary Policys Ability to Stimulate the Economy

When money is injected into the private banking sector, it is expected that the interest rates will reduce, however, sometimes this is not usually the case. It is caused by a combination of factors referred to as a liquidity trap. The liquidity trap is the hoarding of cash by private people in anticipation of deflation, war or insufficient demand. In this case, the supply of money will still remain to be low despite the effort by the FED. It will fail to stimulate the economy.

Factors That Contribute to an Inelastic Demand Curve in Times of Recession and How an Inelastic Demand Curve Reduces the Effectiveness of Monetary Policy in Times of Recession

Inelastic demand is the situation when the total demand for goods and services remains unaffected despite the changes in prices. Recession period is characterized by low levels of economic activities. The production of goods and services is reduced during this period. It implies that the changes in prices of commodities may not increase or decrease the supply of commodities in the market, hence, inelastic demand curve. The monetary policy usually trickles to the people through changes in prices of commodities. The change in prices is supposed to be reflected in the pattern of consumption of commodity. In this case, if the consumption pattern will remain unchanged, then the monetary policy is likely to fail.

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Reasons Why Open Market Operations are the FEDs Favorite Monetary Policy Tools: Shortcomings of the Other Monetary Policy Tools

The OMO, as it has already been shown, is the most effective monetary policy method applied by the FED. It is because the method directly withdraws or injects money from or into the economy. If other methods are applied, there are challenges that are faced. It is because, when private banks are involved, there is money hoarding risk that is hard to control.

The Budget and Government Spending

A balanced budget is the one where the total government inlays equals the total government outlays. It implies that what the government spends equal what the government has or will collect. A budget deficit is the one where the total government outlays exceed the total government inlays. In this case the government spends more than it is able to collect.

A surplus budget occurs when the governments total inlay exceeds the total outlay. In this case, the government spends less than it has been able to collect.

Example:

Year

Inlay

Outlay

Deficit (-) / surplus (+)

2009

2100000

2400000

-300000

2010

2500000

2750000

-250000

2011

3000000

3000000

Nil

2012

3750000

3450000

+300000

Years 2009 and 2010 ran a budget deficit; year 2012 ran a surplus budget; while year 2011 has a balanced budget.

It implies that if the federal government had a debt of $150,000,000 at the beginning of the year 2009, the debt will be (150000000+300000+250000-300000) =$150250000.

The Difference between a Flow Measurement and a Stock Measurement Using the Concepts of Deficits and Debt.

Stock measurement is the total amount of asset balance in a given country at a particular period of time. It involves financial assets, wealth, and money. On the other hand, the flow measurement determines the total value of transactions that take place in a given country. The stock measurement can be used to determine the nature of the budget by accounting for the total value of assets at the beginning and at the end of a fiscal policy.

Reasons Why Government Spending is Wasteful Using Friedmans Four Ways to Spend Money

Spending money during elections when the largest number of voters comes from the non-paying tax, the country is run by the majority who do not contribute to the financing of government activities. On the other hand, it is wasteful of the government to spend money for insuring the unemployed instead of providing new jobs for people.

Keynes Justification for Deficit Spending

John Keyne argues that when the government spending is increased, business activities are stimulated, especially during the economic recession. Thus, when the government makes a deficit spending, the same amount of expenditure will be realized after the economic activity level increase. It will be coupled with increased GDP.

Real Costs of Increasing Government Spending

They include all the activities that the government undertakes such that the public fund is spent not in stimulating economic growth during recession, but to caution the people against the effects of the recession.

The Paradox of Thrift

It is an economic hypothesis which was popularized by John Keynes. It states that the economic recession is usually worsened when people save money. It is simply because saving will scale down the rate of consumption, which in turn, negatively affects the economic growth.

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