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A Central Banks Role In The Economy Economics Essay

An increase in inflation target will lead to a decrease in real interest rate. As interest rate decreases, people are more likely to keep cash instead of saving it in the bank to gain interest, this lead to higher consumption in the economy. On the other hand, people are more likely to borrow money from the bank since there is lower interest rate. This will lead to a higher aggregate demand. As a result, people tend to spend more money in the economy. This boosts the economy and therefore lowers the unemployment rate.

(II) Any policies which imposed shorter working hours without full compensation on workers who want to maintain certain income levels, run the risks of being subverted, through increases in overtime work, increases in multiple job holding and the entry of new workers to the labour force. If a reduction in weekly working hours leads to an increase in labour productivity, there may not be any need for firms to take on additional staff to maintain their level of output. To the extent that reduced hours increase the importance of fixed labout costs, there is a incentive for firms to make greater use of overtime as an alternative to maintaining or increasing their employment levels. To the extent that reduced hours increase labour costs overall, there is an incentive for firms to substitute away from labour towards capital in production processes. To the extent that firms’ output levels are adversely affected by the increase in labour costs, their demand for labour will fall, offsetting any intially positive effects of the reduction in hours on employment.

Case studies and industry surveys show that frequently it has been possible for firms to maintain their output levels with employing any additional staff, due to productivity improvements or greater use of overtime.

Therefore, significant job creation is unlikely to take place under legislation to reduce the length of the working week.

(http://www.workinsight.govt.nz/PDFs/op1994-2.pdf)

In the short run, if firms carry out research and development, they may need to recruit more workers as they may not have enough professionals to undertake the R&D.

In the long run, firms are more likely to run a R&D department; however, they may need more workers to widen the product range in order to expand their business.

For example, the labour force in the industrial sector will be expanded enormously with a rapid expansion of industrial development. Workers may come from all over the world as R&D requires a highly skilled workforce.

To conclude, I think the most efficacious policy is increased incentives to private industry to undertake research and development and the least efficacious one is legislation to reduce the length of the working week as there is a lot of grey area.

Question 2

Monetarists and classical macroeconomists advocate the use of rules. Rules make monetary policy automatic, as they require the central bank to set policy based on a set of simple, prespecified, and publicly announced rules. There are some examples of rules, such as increasing the monetary base by 1% each quarter and maintaining the price of gold at a fixed level. The rule should be simple; there should not be much leeway for exceptions. The rule should specify something under the Fed’s control, like growth of the monetary base, not something like fixing the unemployment rate at 4, over which the Fed has little control. The rule may also permit the Fed to respond to the state of economy.

However, most Keynesian economists support discretion. Discretion means the central bank looks at all the information about the economy and uses its judgment as to the best course of policy. Discretion gives the central bank the freedom to stimulate or contract the economy when needed; it is thus called activist. Since discretion gives the central bank leeway to act, while rules constrain its behavior, why would anyone suggest that the central bank follow rules?

However, new arguments for rules suggest that rules are valuable even if the central bank has a lot of information and forms policy wisely. The new arguments suggest that rules improve the credibility of the central bank. The credibility of the central bank influences how well monetary policy works. One way for the central bank to get credibility is by building a reputation for following through on its promises, even if it is costly in the short run. Another, less costly, way is to follow a rule that is enforced by some outside agency.

Keynesians argue that there may be a trade-off between credibility and flexibility. To be credible, a rule must be nearly impossible to change. If a rule is based on economic relationships that change suddenly, then the lack of flexibility may be very costly. As a result, a rule may create unacceptable risks.

The non-monetary view assumes that the price system works poorly to equilibrate the economy. The successor to the Keynesian assumption that the price system produces a lack of aggregate demand is the assumption that central bank concentration on price stability would produce significant variability in the real economy. Monetary policy is then a balancing act between raising excess unemployment to lower the inflation produced by positive inflation shocks and reducing excess unemployment by raising inflation to mitigate negative real shocks .Intrinsic inflation makes possible the discretionary manipulation of unemployment, but makes the control of inflation costly.

In conclusion, I think there are more advantages on discretion over rule. Therefore, discretion is a better way to control the aggregate demand.

Question 3(a)

Since July 2008, the pound has depreciated against the US dollar. During March 2009, the pound appreciated against the US dollar – but in November 2009 the dollar has regained some ground – sterling has depreciated back.

The pound has depreciated against the Euro since October 2007. During December 2008, the pound has started to appreciated back to 0.85 but then depreciated again until 2010.

The pound has been depreciated steadily against the Australian Dollar from the start of 2007 until July 2007.The pound then appreciated sharply and depreciated back from October 2007. After October 2007, it is kept depreciating until now.

Since August 2008, the pound has depreciated against the Japanese Yen. During January 2009, the pound appreciated against the Japanese Yen – but in August 2009 the Yen has regained some ground – sterling has depreciated back.

The pound has depreciated against the Canadian Dollar throughout the period from the start of 2007 to 2010.

Since the start of 2007, the pound has depreciated against the Swiss Franc. During December 2009, the pound appreciated against the Swiss Franc - but in August 2009 the Swiss Franc has regained some ground – sterling has depreciated back.

The exchange rate between the Hong Kong Dollar and the sterling remains stable between the period of the start of 2007 and August 2008. The pound then depreciated against the Hong Kong Dollar until March 2009. It then appreciated back to 0.085.

The exchange rate measures the external value of sterling in terms of how much of another currency it can buy. For example – how many dollars or Euros you can buy with £5000.

The stability of the UK terms of trade might reflect the pricing strategies adopted by UK exporters and foreign exporters to the United Kingdom. It would be consistent, for example, with equal proportions of UK exporting companies pricing in foreign currency and foreign exporting companies pricing in their own domestic currency. In fact, sterling export and import prices have both increased by only a little less than the exchange rate depreciation. That might suggest that a significant proportion of UK exporters have been foreign currency pricing, and a significant proportion of exporters to the United Kingdom have been home currency pricing.

Between 2007 and 2009, the sterling effective exchange rate depreciated by around 20%, yet the UK terms of trade remained broadly unchanged. There are a number of factors that can influence the response of the terms of trade to movements in the exchange rate. And the exchange rate itself is only one possible explanation behind any movement in a country’s terms of trade.

The recent stability of the UK terms of trade reflects the fact that sterling import and export prices have risen by similar amounts and by only a little less than the overall exchange rate depreciation. The stability of the aggregate UK terms of trade can largely be explained by the relative stability of the goods terms of trade. This can be explained by a small rise in the terms of trade for manufactured goods being broadly offset by a fall in the terms of trade for food and basic materials.

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