You are on page 1of 16

___________________________________________________

CODE: AIM 1007 PRINCIPLE OF MACROECONOMICS


____________________________________________________

ASSIGNMENT

NAME NRIC

: TAN GEOK LIAN : 920103-10-5078

H/P NUMBER : +60163763910 STUDENT ID : 200551

DECEMBER 2011SEMESTER

1.0 CONTENT

NO 1.0 2.0 3.0

TOPIC CONTENT INTRODUCTION

PAGES 1 2-3 4-5

GOALS OF MONETARY POLICY FACTORS CONSIDERED BY THE MONETARY POLICY COMMITTEE 3 FACTORS OF MONETARY POLICY AND ITS EFFECTS ON MACROECONOMICS -UNEMPLOYMENT -FOREIGN TABLE -INFLATION -PRODUCTION AND CONSUMPTION

4.0

6-7

5.0

8-9

6.0 7.0 8.0

CONCLUSION REFERENCE COURSEWORK

10-11 12 13-15

2.0 INTRODUCTION Macroeconomics (from Greek prefix "makros-" meaning "large" + "economics") is a branch of economics dealing with the performance, structure, behavior, and decision-making of the whole economy. This includes a national, regional, or global economy.With microeconomics, macroeconomics is one of the two most general fields in economics. Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price indices to understand how the whole economy functions. Macroeconomists develop models that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance. In contrast, microeconomics is primarily focused on the actions of individual agents, such as firms and consumers, and how their behavior determines prices and quantities in specific markets. While macroeconomics is a broad field of study, there are two areas of research that are emblematic of the discipline: the attempt to understand the causes and consequences of short-run fluctuations in national income (the business cycle), and the attempt to understand the determinants of long-run economic growth (increases in national income). Macroeconomic models and their forecasts are used by both governments and large corporations to assist in the development and evaluation of economic policy and business strategy Macroeconomics encompasses a variety of concepts and variables, but three are central topics for macroeconomic research.Macroeconomic theories usually relate the phenomena of output, unemployment, and inflation. Outside of macroeconomic theory, these topics are also extremely important to all economic agents including workers, consumers, and producers. Microeconomics (from Greek prefix micro- meaning "small" + "economics"). Microeconomics is a branch of economics that studies how individuals, households, and firms make decisions to allocate limited resources, typically in markets where goods or services are being bought and sold.

Microeconomics examines how these decisions and behaviors affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the supply and demand of goods and services. Microeconomics has been called the bottom-up view of the economy, or how people deal with money, time, and resources. One of the goals of microeconomics is to analyze market mechanisms that establish relative prices amongst goods and services and allocation of limited resources amongst many alternative uses. Microeconomics analyzes market failure, where markets fail to produce efficient results, as well as describing the theoretical conditions needed for perfect competition. Significant fields of study in microeconomics include markets under asymmetric information, choice under uncertainty and economic applications of game theory.

3.0 GOALS OF MONETARY POLICY Monetary policy is the manipulation of the most general economic factors of a society by the central banks. These factors include the supply of money, inflation and interest rates. These are the main factors in any economy, since they send "signals" to the investment community that it is a good or bad time to invest. When rates are low it is a good time to invest because money is cheaper and the central bank is optimistic about the economic climate. According to the Federal Reserve Bank of San Francisco, the most important goal of monetary policy is to maximize production. However, it adds a caveat to that -- namely, "stable" production. Stability, therefore, is the most important goal, since production outside of a stable monetary environment is destructive. Stability is the most important aspect of monetary policy because it reassures investors. If the money supply, rates or inflation are not stable, then your investment can lose its value almost instantly. Even when economic times are good, investors will avoid putting money into the economy because there is no assurance that the economy will be able to keep its value for very long. One of the goals of monetary policy is monetary equilibrium. This is true for any monetary arrangement that claims to serve a general interest among the population rather than to simply divert wealth to the ruler and his cronies. Monetary equilibrium is a situation where the supply of money equals the demand, given a particular constellation of prices. The supply of money includes both the monetary base and various forms of credit. In monetary equilibrium, the monetary system is doing the most it can to facilitate beneficial trades. An excess supply of money induces people to make some trades that market participants will later judge not to have been beneficial. A deficient supply of money hinders people from making some beneficial trades. Beside that , high employment is another goal of monetary policy.The movement of workers between jobs is referred to as frictional unemployment. All unemployment beyond frictional

unemployment is classified as unintended unemployment. Reduction in this area is the target of macroeconomic policy. Historically, under the gold standard of currency valuation, the primary goal of monetary policy was to protect the central banks gold reserves. When a nations balance of payments was in deficit, an outflow of gold to other nations would result. In order to stem this drain, the central bank would raise the discount rate and then undertake open-market operations to reduce the total quantity of money in the country. This would lead to a fall in prices, income, and employment and reduce the demand for imports and thus would correct the trade imbalance. The reverse process was used to correct a balance of payments surplus. The inflationary conditions of the late 1960s and 70s, when inflation in the Western world rose to a level three times the 195070 average, revived interest in monetary policy. Monetarists such as Harry G. Johnson, Milton Friedman, and Friedrich Hayek explored the links between the growth in money supply and the acceleration of inflation. They argued that tight control of money-supply growth was a far more effective way of squeezing inflation out of the system than were demand-management policies. Monetary policy is still used as a means of controlling a national economys cyclical fluctuations. Monetary policy can be used to control inflation. Inflation is defined as continuing increases in price levels. Since price level is a monetary variable, monetary policy can affect it. Contractionary monetary policy has the effect of reducing inflation by reducing upward pressure on price levels. Note that inflation can also be affected by fiscal policy. However, contractionary fiscal policy is often politically unpopular, because it involves spending cuts and tax increases. Thus, politicians favor the use of monetary policy to control inflation.

4.0 FACTORS CONSIDERED BY THE MONETARY POLICY COMMITTEE

Monetary and fiscal policies have impact on the total economy. Those macroeconomic policies shape, and guide and control the behavior of the economy. The following factor needs to be considered in making monetary and fiscal policy: First, the inflationary state of the economy.If the economy suffers higher inflation then increasing money supply through monetary policy can be ineffective. So in making monetary and fiscal policy this factor should be considered Secondly, marginal propensity to consume.The willingness of people to consume is another factor in making those policies. Suppose if people's tendency is to consume whatever the interest rate is then monetary and fiscal policy may be ineffective Thirdly, the government's estimated GDP target. Every government has specific GDP target. Government makes policy to achieve the estimated GDP target. So this should be taken into consideration in making monetary and fiscal policy. Next factor that should be consider is economic condition of a country. When the economy is in a recession, monetary policy may be ineffective in increasing spending and income. In this case, fiscal policy might be more effective in stimulating demand. Beside that, the present interest rate in the market.In setting the policies another considerable factor is the present interest rate. The present interest rate determines whether expansionary. In the other hand, the factor should be consider is government revenue target. In each and every year government sets specific revenue target. Through the budget govt. specifies it. So in making fiscal policy it should be considered. Suppose, in contractionary policy tax is reduced. If this happens then the policy contradicts with the aim to achieve revenue target. The next factors should be consider in monetary policy is government policy toward import and export. Sometimes government wants to bar against import or export, so in making fiscal policy and monetary policy this should be taken into consideration. Reducing export duty or imposing import duty to any industry can have an impact on govt. policy.

If government want to privatize and encourage private sector to grow, government will take privatization policy. In this case govt. will give facilities to the private sector by lowering taxes and decreasing interest rate through monetary and fiscal policy and vice versa. So govt. perspective on privatization is another important considerable factor. Balance of payment is another important factor. If the government wants to decrease trade deficit certainly it can encourage export and discourage imports. So, monetary policy will reflect the desire of government. Next, influence of Donor institutions and countries. As a third world and developing country like Bangladesh, where we are dependent on huge loan from the international organization. The influence of those organizations sometimes can be a considerable factor in making monetary and fiscal policy. In our country IMF and EU always pressures govt. to increase the deposit rate. So in policy making this is a considerable factor for the government.

5.0 FACTORS OF MONETARY POLICY AND ITS EFFECTS ON MACROECONOMIC There are three factors have shaped the outlook and monetary policy for 2011-12. First, global commodity prices, which have surged in recent months are, at best, likely to remain firm and may well increase further over the course of the year. This suggests that higher inflation will persist and may indeed get worse. Second, headline and core inflation have significantly overshot even the most pessimistic projections over the past few months. This raises concerns about inflation expectations becoming unhinged. The third factor, one countering the above forces, is the likely moderation in demand, which should help reduce pricing power and the extent of pass-through of commodity prices. This contra trend cannot be ignored in the policy calculation. However, a significant factor influencing aggregate demand during the year will be the fiscal situation. Monetary policy affects trade activity. When monetary policies cause the dollar to grow weaker, imports become more expensive in the United States. On the other hand, domestic firms sell more goods overseas because the price of US goods and services are cheaper. One way the Fed strengthens or weakens the dollar is through the deposit multiplier that determines how much money banks can lend based on the amount of their deposits. If, for instance, the deposit multiplier is 10, the bank may lend $100 with just $10 in deposits. Allowing banks to hold less money in deposits to loan out money, increases the dollars in circulation and weakens currency. Beside that,monetary policy also affects inflation. This is because prices of domestic goods and services rise or fall based on monetary policies. Prices rise when the Fed increases the money supply by lowering the interest rate or buys assets as part of a quantitative easing program. When more money is in circulation, consumers need more dollars to purchase things. William Baumol, author of "Economics: Principles and Policy," explains the Fed faces a Catch-22 when lowering interest rates -- while this action boosts the unemployment rate, a consequence is inflation, or rising prices.

Next, monetary policy affects in unemployment too. Lowering the interest rate is seen as one method of combatting high unemployment. In theory, lower interest rates provide businesses with easier access to credit by virtue of the lowered cost of borrowing money. Businesses use these loans to grow, thereby hiring more workers to fill the need. This hiring spree, in turn, improves the unemployment rate. However, lowering interest rates is ineffective at boosting the employment rate if businesses cannot receive a loan due to poor credit or if financial institutions are especially risk-averse. Lastly, monetary policies affect production and consumption in a number of ways. When investors believe a policy will make the economy worse off, this is reflected in a dip in the stock market. A plunge in the stock market lowers consumer confidence and therefore reduces consumption. When consumers buy fewer goods and services, producers earn less money. This reduction in profit may result in layoffs, which perpetuates a vicious cycle of lowered production and consumption.

6.0 CONCLUSION Like other forms of economic policy, monetary policy comes with a set of advantages and disadvantages. One of the advantage of monetary policy is low inflation.The two goals of monetary policy are to promote maximum sustainable levels of economic output and foster a stable price system. Stable prices mean keeping inflation low, and the Federal Reserve Bank of San Francisco concedes that low inflation is all that monetary policy can achieve in the long run. Inflation reduces the purchasing power of money, harming economic growth. In contrast, stable prices enable households and businesses to make financial decisions without worrying about sudden, unexpected price increases The next advantage of monetary policy is political independence.When central banks operate free of political pressures, they are free to make policy decisions based on economic conditions and the best available data on economic performance, rather than short-term political considerations imposed by elected officials or political parties. The U.S. Federal Reserve operates with a high level of political independence, even though it is accountable to Congress. Federal Reserve board members are presidential appointees but have staggered terms to make it more difficult for a president to load the board with favorite appointees. When central banks lack this independence, monetary policy becomes subject to political pressures. Harvard economist Greg Mankiw, for example, writes that central bankers that lack political independence may manipulate monetary policy in a manner favorable to the political party in power However, monetary policy has its disadvantages too. For example, conflicting goals.The Federal Reserve and other central banks can use monetary policy to achieve low inflation in the long run and affect economic output and employment in the short run. The Federal Reserve Bank of San Francisco reports that these goals sometimes conflict. Reducing interest rates to expand the money supply and stem rising unemployment rates during a recession, for example, could spark future inflation if monetary

10

policy remains expansionary for too long. The best monetary policy seeks to strike a balance between these short- and long-term goals. On the other hand, the disadvantage of monetary policy including time lag. In contrast to fiscal policy, which quickly stimulates additional money into the economy as governments increase spending for government programs and public projects, monetary policy actions take time to work their way through the economy, especially a large modern economy such as that of the U.S. and other world economic powers. The San Francisco Fed estimates that monetary policy actions to affect output and employment can take three months to two years for their effects to be felt. Actions may take even longer to affect inflation -- sometimes more than two years.

11

7.0 REFERENCE 1.http://en.wikipedia.org/wiki/Macroeconomic 2.http://en.wikipedia.org/wiki/Microeconomic 3.http://ezinearticles.com/?16-Factors-to-Consider-in-Determining-and-Establishing-Monetary-andFiscal-Policy&id=4370882 4.http://www.ehow.com/info_8239910_advantages-disadvantages-monetary-policy.html 5. http://www.oppapers.com/essays/Monetary-Policy-Effect-Macroeconomics/133569

12

___________________________________________________

CODE: AIM 1007 PRINCIPLE OF MACROECONOMICS


____________________________________________________

COURSEWORK

NAME NRIC

: TAN GEOK LIAN : 920103-10-5078

H/P NUMBER : +60163763910 STUDENT ID : 200551

DECEMBER 2011SEMESTER

13

1.Please describe the change in demand. You may use the graph to make your description. Answer: Price

Decrease

Increase

D2

D1
Quantity

It is essential to distinguish between a movement along a demand curve and a shift in the demand curve. A change in price results in a movement along a fixed demand curve. This is also referred to as a change in quantity demanded. For example, an increase DVD prices from $ 3 to $ 4 reduces quantity demanded from 30 units to 20 units. This price change results in a movement along a given demand curve. A change in any other variable that influences quantity demanded produces a shift in the demand curve or a change in demand. The terminology is subtle but extremely important. The majority of the confusion that students have with supply and demand concepts involves understanding the differences between shifts and movements along curves. Suppose that incomes in a community rise because a factory is able to give employees overtime pay. The higher incomes prompt people to buy more DVDs. For the same price, quantity demand is now higher than before.

14

2. What is command system? Explain carefully. Answer: The command system is also known as socialism or communism. In that system, government owns most property resources and economic decision making occurs through a central economic plan. A central planning board appointed by the government makes nearly all the major decisions concerning the use of resources, the composition and distribution of output, and the organization of production. The government owns most of the business firms, which produce according to government directives. The central planning board determines production goals for each enterprise and specifies the amount of resources to be allocated to each enterprise so that it can reach its production goals. The division of output between capital and consumer goods is centrally decided, and capital goods are allocated among industries on the basis of the central planning boards long term priotities. A pure command economy would rely exclusively on a central plan to allocate the governmentowned property resources. But, in reality, even the preeminent command economy- the Soviet Uniontolerated some private ownership and incorporated some markets before its collapse in 1992. Recent reforms in Russia and most of the eastern European nations have to one degree or another transformed their command economies to capitalistic , market oriented systems. Chinas reforms have not gone as far, but they have greatly reduced the reliance on central planning. Although government ownership of resources and capital in China is still extensive, the nation has increasingly relied on free markets to organize and coordinate its economy. North Korea and Cuba are the last prominent remaining examples of largely centrally planned economies. Other countries using mainly the command system include Turkmenistan, Laos, Belarus and Iran.

15