Running Head: MONEY AND THE PRICES 1

Money and the Prices in the Long Run and Open Economies

Name

Institution Affiliation
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The history of changes in GDP, savings, investment, real interest rates, and unemployment

as compared to forecast for the next five years.

The United States economy faces a lot of challenges, both domestic and in the

international market. The US economy is substantially the largest despite the challenges it faces.

Twenty percent of the world economy can be attributed to the United States, a figure that is

significantly larger than that of China which is the second largest economy in the world. Almost

80% of the U.S economy is attributed to the service sector, whether the financial sector, health

sector, among others. The manufacturing industry has also played a great part in promoting the

economy and competent legal sector as well as a stable political system brings sanity to the US

economy. However, a chain of housing crises, income inequalities, wage stagnation and budget

deficits have put a dent in the economy.

The United States Gross Domestic Product (GDP) has averaged a growth rate of 3.22

percent from 1947 to 2017. It was at its highest in the first quarter of 1950 at 16.90 percent and

lowest at the first quarter of 1958 at -10%. The GDP growth rate of the US economy is expected

to be two percent and 2.1% in the next one year. IN the long term the GDP growth rate is

expected to trend around 2.00% in the next five years. As at July 2017, the saving rates were at

3.50 percent, and historically, the rates of savings have averaged a rate of 8.31 percent, with the

highest recorded at 17% in May 1975 and lowest at 1.90% in July 2005 (U.S. Bureau of

Economic Analysis, 2017). In the long term, the saving rates are expected to trend around 4.60

percent in five years to come.

The real interest rates in the United States were 1.25 percent in July 2017. Historically,

the real interest rates have averaged 5.78 percent from 1971 until 2017 with the highest rate of 20

percent recorded in March of 1980 and lowest of 0.25 percent in December of 2008. The rate is
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expected to remain at a constant figure of 1.25 percent in the twelve months and the projected

trend in five years’ time is expected to be 2.25 percent. The unemployment rates in the United

States unexpectedly rose from 4.3 percent in July 2017 to 4.4 percent in August this year, and

this implicates that the unemployed persons increased by 151 in one month to reach 7.1 million.

Since 1948, the rates of unemployment have averaged 5.80 percent with the highest recorded rate

of 10.80 percent recorded in November of 1982 and lowest rate of 2.50 percent in May of 1953.

By the end of this quarter, the unemployment rates in the United States are expected to remain at

4.40 percent and increase to 4.60 in 12 months’ time (U.S. Bureau of Economic Analysis, 2017).

In the long term, the trend is expected to sour, and this can be associated with the prevailing

adverse economic challenges. The situation is expected to raise the level of unemployment to

trend at around 6.00 percent in five years’ time.

How government policies can influence economic growth.

Government policies influence economic growth in various ways, either through the use

of the monetary policy or the use of the fiscal policy. The government, through the monetary

policy, exercises its authority through the use of the Federal Reserve which is the central bank

that manages liquidity to sustain the United States economy. The monetary policy is the most

common tool that the government uses to instigate economic growth. If the Federal Reserve

lowers interest rates charged by banks and other financial institutions, it will, in turn, reduce the

cost of borrowing. People will be encouraged to borrow for investment purposes. Also, it will

encourage consumer spending. Low-interest rates have the potential of discouraging the

consumers to save, and instead, they spend more (Barro & Salai, 2014). It becomes even

instrumental when interest rates charged on mortgage payment are lowered because it leads to an

increase in the number of consumers with a high disposable income.

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Fiscal policy is the other policy that can be used by the government to influence

economic growth. The fiscal policy revolves around taxes and government spending. In this case,

the government cut down taxes and increases its expenditure. If the government lowers taxes on

incomes, people will have more disposable income which they will spend. On the other hand, if

the government increases its expenditure, it will contribute to the creation of more jobs ad with

more employment; the economy will realize a significant growth (Barro & Salai, 2014).

However, this policy is disadvantageous as it leads to increased government borrowing. In such a

case where the government wants to borrow more money from the private sector, in the long-run,

it will have to raise taxes. Therefore, if the private spending in an economy decreases and

savings increase, an expansionary fiscal measure should be put in place to boost the economy

without forcing the government to overspend.

The government can stimulate the economy through investing in it. Such investments

may revolve around education, preventative healthcare, infrastructure, and market production.

Stimulation of economic growth involves the creation of jobs and lifting of stagnant wages in the

economy which in turn calls for public investments like education. These public investments are

a perfect avenue of any pro-growth budget which aims at addressing inconsistent, full

employment, slow economic growth and stagnant wages prevailing in the economy.

Furthermore, such public investments try to address economic inequality which has a negative

drag on the overall economic growth.

Monetary policy’s influence on the long-run behavior of price levels, inflation rates, costs,

and other real or nominal variables.

Monetary policy is exercised by the government through the use of a central

government’s monetary authority. In the United States, the central monetary authority is the
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Federal Reserve which has the mandate of controlling the money supply in the economy as well

as instigating economic growth and stability, lower the unemployment rates, and use the trade

markets to maintain proper exchange rates with foreign countries (Mankiw, 2017). Monetary

policy doesn’t affect growth in the long-run, but poor monetary policies result to inflation. The

high and varying inflation is responsible for impeding economic growth in some ways. First, the

varying and high inflation tampers with the capability of relative prices to provide the correct

signals for guiding the allocation and the use of resources for their highest value. However, if the

inflation causes a simultaneous and uniform rise in prices, then it wouldn’t have any effect on

relative prices and the demand and supply patterns would not be affected.

The other way in which a poor monetary policy limits the performance of the economy is

through encouraging wasteful spending of resources by the people. The usually spend in such a

manner because they are afraid to hold money. It is clear that inflation is a bad instrument for

saving because the longer you hold out your money; the more it loses its value (Mankiw, 2017).

People, therefore, prefer to keep their money holdings as low as they can and therefore they will

at all times make frequent and smaller withdrawals from their bank accounts. Such

economization replicates to the lost opportunity because such money could have been spent on

the production of goods and services.

How trade deficits or surpluses can influence the growth of productivity and GDP.

Trade deficits and surpluses are some of the components of a country’s Gross Domestic

Product (GDP). Trade deficits and surpluses revolve around the regulation of exports and

imports in the economy. A country’s GDP increases when the total value of goods and services

produced domestically sold in the foreign market exceeds the total amount of goods and services

produced and sold in the domestic market by foreign producers. It simply means that a trade
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deficit is realized when imports exceed the exports while a trade surplus usually occurs when

exports exceed imports. The balance of trade has the potential of influencing the growth of

productivity and the GDP. Such a scenario occurs when barriers to trade, fiscal policy, factors

endowments and productivity, and investment activities in a country directly affect international

trade (Mankiw, 2017).

Once the determinants of economic growth are accounted for, trade imbalances have an

insignificant effect on the economic growth rates. Over time, a country’s lending or borrowing

profile is reflected in the trade deficits or surpluses. Countries have similarities to companies in

that they borrow capital to finance purchases and investments. Trade deficits are an indication of

a weak economy whereas surpluses indicate otherwise but not in the long run. In any way, trade

deficits and surpluses are important elements in the efficient allocation of economic resources

and international risk sharing. Such an obligation is necessary for promoting the long-run health

of the world economy.

Creation of trade deficits leads to more regulations on imports. In such a case, more

tariffs and import taxes are imposed by individual countries, and the United States can adjust

these regulations as it likes in accordance to what a new administration desires. Surpluses, on the

other hand, cause the U.S treasury to buy more of its treasury shares and lower inflation. Also, it

will instigate an increase the country's GDP by creating less money in the economy and

empower households for purchase purposes (Mankiw, 2017). The deficits are the ones that hurt

the economy which may even force the U.S government to inject money into the economy to

increase the effectiveness of companies to borrow and increase productivity in the economy.

The importance of the market for loanable funds and the market for foreign-currency

exchange
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The market for loanable funds is made up of lenders and borrowers who give out the

funds and demand the funds respectively. Countries determined to invest in foreign countries

have to understand the market of loanable funds and foreign exchange in their country of

interest. The real interest rates usually rely on loanable funds. Banks usually create loans out of

deposits made clients and the real interest rate affect the rate of money growth and subsequent

inflation. A country, therefore, has to consider the interest rates in both the home country and the

foreign country and always attempt to borrow from a country with the lowest interest rates.

The United States is known for lending money to other countries for developmental

purposes. However, these loans are expected to be repaid, and the interest attached to these loans

boost the economic growth in the United States (Choudhri, Hakura & International Monetary

Fund, 2015). If the country experiences an increased economic growth, firms in such a nation

will be able to achieve strategic plans.

On the other hand, the foreign exchange market affects a country’s purchasing power as

well as international and national credit. Also, a country is only able to reduce its foreign

currency risks and minimize its debts through the use of the foreign market. The United States is

always determined and has put various measures to make sure that the dollar is superior to other

currencies. Such a move ensures that United States companies operating in foreign countries can

easily achieve a foreign bargain (Choudhri, Hakura & International Monetary Fund, 2015). Also,

it ensures that the companies can import raw materials at an affordable cost and therefore they

continue to remain productive in foreign countries. Therefore, it helps the firms to achieve their

strategic plans of increased productivity and growth.

Trade restrictions lead to an increase in net exports. When this happens, there is an

increase in the amounts of dollars in the foreign currency exchange. As a result, goods from the
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local market become expensive whereas foreign goods become cheap. The result is offsetting of

the initial situation on trade restrictions on exports.

Recommendations

A strategic plan can be achieved, but for practicability purposes, it can only be achieved

when the government puts in place various measures. The Federal government has to put in

measure various measures in related to tariffs, taxes, and volume limitations. Also, capital

control measures must be put in place if a strategic plan is to be achieved. Increasing the net

investments on exports requires the government to come up with a plan which makes the U.S

treasures and the U.S currency attractive to foreign investors and lure them to purchase. If such

measures are put in place, and company with a strategic plan that wishes to expand and venture

into foreign market locally will be in a position to quencher its ambition.

As foreign investors continue purchasing the U.S dollar as well as the U.S treasuries, this

implies raising government’s investments on exports. As the economy improves, comprehensive

monetary policy tends to lessen, and interest rates reduce. High returns on the dollar and the

securities attract more investors in the United States (Wang, 2013). Considering the current

trends on global financial; integration, the U.S can purchase a substantial amount of assets to

raise the capital inflow and keep the dollar superior compared to other currencies. The federal

government can also uphold certain measures to effectively devalue the dollar against key

currencies to promote companies’ strategic plans.

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References

Barro, R. J., & Salai, X. (2014). Economic growth. Cambridge, Mass: MIT Press.

Choudhri, E. U., Hakura, D. S., & International Monetary Fund. (2015). The exchange rate pass-

through to import and export prices: The role of nominal rigidities and currency choice.

Washington, D.C: International Monetary Fund, Institute for Capacity Development.

Mankiw, N. G. (2017). Principles of microeconomics. Boston: Cengage Learning

U.S. Bureau of Economic Analysis, (2017)U.S. Economic Accounts, Retrieved from

https://www.bea.gov/

Wang, J. C., (2013). Loanable funds, risk, bank service output. Boston, Mass.: Federal Reserve

Bank of Boston.