Macroeconomics as a whole studies the performance of an economy of a country. More particularly the focus of macroeconomics is on the economy at national level and the interaction between the national economy and the other national economies of the world. The following section discusses the questions asked in the assignment in details.
Discussion Discuss the following argument: “Since inflation reduces one’s purchasing power, the government and the central bank should not set a 2-3 per cent inflation target over the course of a typical business cycle; instead, they should restrict and adhere to a 0 per cent inflation target. ” Inflation is one of the most commonly used and recognizable term throughout economics. This very phenomenon has forced many countries into extended periods of instability. And so the question arises what is inflation and why is it so important?
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Inflation is the rate at which the prices increase over a period of time. Inflation can be used to describe the price hike in broad sense as well as in narrow sense (?nerd, 2012, p. 1). To control and tame inflation governments and central banks all over the world use the policy framework of inflation targeting (Sterne, 2002, up. 3-77). Central banks all over the world try to steer the actual inflation rates towards the target inflation rate using tools such as changes in interest rate.
The logic behind this is that inflation rate and interest rates move in opposite way and so any steps to increase or decrease the interest rate will become more visible under an inflation targeting policy which leads to economic stability as supported by many advocates of the inflation targeting theory. All the sources that were reviewed clearly pointed out that the inflation target rate of zero percent is not suitable instead a 2-3 percent rate of inflation target is more favorable for an economy.
If the inflation target rate is set at zero percent by the central bank there will be no boost to the economy as the interest rates would not fall adequately to encourage the overall demand (Roger, 2010, up. 46-49). Zero percent inflation target rate can lead to deflation as well. Since some wages and price levels may not be adjusted downwards due to deflation it can become quite costly. This phenomenon is known as “downward nominal rigidities” (ARAB, n. D, p. L). Moreover inflation target rate of zero will result in a loss in output and consequently lead o unemployment because prices and wages respond slowly in this regard.
George Karaoke et. Al (1996) state that moderate inflation rate (2-3 percent) can lead to noteworthy efficiency increase. According to them firms normally use the inflation rates to make adjustments in the wages and at zero percent inflation nominal wage cuts would be more common. This scenario then results in loss of output and in order to cope of with that unemployment arises. Due to all these reasons an inflation target rate of 2-3 percent is more suitable for an economy. Why is the United States, with the world’s largest economy, borrowing heavily on international capital markets, rather than lending, as would seem more natural?
What implications do the U. S. Trade deficit and the United States’ reliance on foreign credit have for the performance of the U. S. Economy? United States, the world’s largest economy has also the largest deficit and is a debtor country. In my search to this question I found two reasons as to why U. S is a heavy borrower of capital. The first reason for the mounting debt is the current account balance. Economist and scholars are concerned over the fact that the largest economy has hanged from a nation giving credit to a debtor nation (Mongo, 201 0, up. 2-5).
Fig 1 clearly shows the current account deficit and to finance it US needs to pull the same amount of excess foreign savings. This leads us to our second reason for mounting debt on United States. The third world economies that suffered the 1997 financial crisis took the path of gathering hoards of assets in foreign countries as a precaution. Emerging economies are most likely to build dollar reserves by keeping their own currency weak so that it results in more exports which then results in the borrowing by the plopped countries to manage their imports (Lange, 2014, p. L).
The range of the trade deficit and foreign debt on U. S is eventually ingrained in the macroeconomic circumstances in the U. S and other countries. In simple terms the savings in U. S are far less than what is required to finance the investment. This shortfall of savings to investment has been major reconciled by foreign capital inflows. So if foreign investor somehow looses interest in investing in U. S, the foreign investment would be brought down. Less investment will slow down the economy since there would not be enough foreign funds to et the internal demands or the external obligations.
Exchange rates and interest rates would also come under fire if the foreign investment is pulled out of American market. Simultaneous selling of dollar assets will sharply decrease the exchange rate and lower prices of assets. The lower asset prices will increase the interest rates and that increase will stress the financial markets. However, in terms of output and employment, trade deficit is a source of expanding the amount of services and goods accessible to domestic consumers.
A country having trade deficit ( more imports) signifies that either the production n the country has reached its optimal level or the country does not have the expertise, infrastructure or the resources to produce a certain good so both foreign and domestic output is used to fill that gap. So there is no decrease in the locally produced output or increase in unemployment, outside of recession (Lowell, 2010, up. 13-16). According to Bloomberg News, 1 1 January 2012, “Banks are hoarding the European Central Bank’s record 489-billion Euro injection into the banking system, thwarting attempts by policy makers to avert a credit crunch.
Banks have used the funds to increase reserves rather than make loans. Why would banks keep the increase in funds as reserves rather than lending them? If the banks had lent the funds, how would the European money supply and interest rates have changed? The Euro zone debt crisis was the prime reason that a majority of banks across Europe were building up their reserves instead of lending that money in the system. This predicament surfaced when the global economy came out of the 2008-2009 financial crisis in United States with a slow growth.
This exposed largely the unsustainable and flawed fiscal policies around the globe and particularly in Europe. Spain, Italy, Ireland, Portugal and Greece which failed to pay back their debts due to a decrease in economic activity. Even though these countries were on the brink of immediate default, the crisis was not limited to these countries only. So the Euro debt crisis, in addition to the regulatory and economic uncertainty, lead the banks to accumulate cash instead of lending it. Depositing huge amount of money as reserve gives a great reassurance to the investors, regulators and the market.
This way market takes the respective banks as well as their balance sheet safe if they don’t hold so much cash (Enrich, 201 0, p. ). And investor confidence means more business for the banks. However if the banks had lent the money to the markets, business and consumers, this would have increased the money supply in the system. Since banks now have money to lend so the interest rate would have come down to encourage borrowing. This money would then be used in businesses and markets to increase consumption and economic activity which would have resulted in an increase in the growth rate and GAP overall.
Since money is utilized in almost all the transactions in an economy it thus has a very important effect on a country’s economic activity. As mentioned above, more money supply leads to lowering of interest rates which not only increases investment but also encourages spending since consumers with more money at hand generally feel wealthier (Schwartz, n. D ). This whole scenario would have mitigated the Euro debt crisis to some extent. The Australian Prime Minister is considering placing a tariff on the import of Japanese luxury cars. Discuss the economics and politics of such a policy.
In particular, how would the policy affect the Australian trade deficit? How would it affect the exchange rate? Who would be hurt by such a policy? Who would benefit? Tariff is defined as a tax that is placed on the export or import of goods. Usually tariff is taken in terms of import duties that are levied at the time when merchandise is imported. Although the present scenario states that the Australian trade deficit has narrowed down, the policy of import tariffs in my view is the right step in curbing and further minimizing the trade deficit.
One of the ways to address the problem of trade deficit is to put the import tariff or if increase it if it is already levied on imports (Knees, 2014, p. 1). Since the cost of importing the luxury car would increase consumers would rely more on locally manufactured cars which will keep the capital in the country instead of sending it out as import payments. In addition, the imbalance between high imports and the relatively low exports will also lesson, thus reducing the trade deficit. The exchange rate affects trade surplus or trade deficit which in result affect the exchange rates like in a cycle.
Scholars have noted that increasing amount of imports or a rising level of trade deficit has a negative effect on the exchange rate of a country (Piano, 2001, p. L). In this case tariff is being placed on import of luxury cars so the effect on the exchange rate would be positive. According to Reserve Bank of Australia, Australia has a free floating exchange rate. Floating exchange rate takes the value of whatever demand and supply dictate (Greenville, 2000, p. 53). If Australian dollar becomes expensive foreigners will find Australian goods expensive and they will reduce the amount of exports.
The net effect of import tariff on luxury cars and a floating exchange rate is that it cuts not only the imports but also hurt exports. Consumers, car importer and car dealer of the Japanese Luxury cars would be hurt from the import tariffs. In order to import the dealers and importers will eave to pay taxes which means that they will have to pay much more than what they were paying before. The end effect of this increase in import prices is then ultimately passed on to the consumer. In this scenario the local car manufacturing would benefit as they will be getting higher prices since there would be less competition.
Moreover the government is also a beneficiary if the import duty is levied on luxury cars (Baseball and Maier, 2014, p. L). Devoting a larger share of national output to investment would help restore rapid productivity growth and rising living standards. ” So you agree with this claim? This claim needs to be assessed in the short term as well as in the long term. In the short term when the large amount of national output would go to investment it would increase the saving rate. Let us assume that the economy is at the initial stage of the steady state.
For definition purposes a steady state is when the output per worker and capital per worker is the same. So in the early stage of steady state the investment which leads to a higher saving rate will create optimistic growth as capital per head and income per head is higher. This increase will translate into higher living standards. But once that optimal level of he steady state is achieved growth will cease in capital per head and so in the long run the growth cannot be sustained. Therefore the increase is investment rate does amplify the growth rate only in the short term, but it dampens growth in the long run.