Money and Prices in Open Economies

Inflation rates are influenced by the amount of money in circulation. Because customers have more money to spend and can, therefore, afford whatever prices are in the market when there are more dollars in circulation, inflation rates rise. The inflation rate does, however, decrease when there is little money in circulation because consumers cannot afford to pay for increasing costs with little money in their accounts or on hand. The amount of money in circulation and interest rates both have an effect on the long-term trend of commodity prices (Garratt, Lee, Pesaran, & Shin, 2012). This essay will discuss how in the long run, money affects prices and also the growth of the economy through GDP any other economic factor. The essay will answer these questions by discussing various economic aspects about GDP, money, and prices.

The GDP of the United States of America has been varying each year. In 1929, the GDP was at 1.05 trillion dollars. A year later, it went down to 0.97 trillion dollars. This represents about 9n percent decrease. After this some years later, 1950 to date, the GDP has been on the rise. GDP stood at 300 billion dollars in 1950 and 17,946 billion dollars in 2005.

Economic forecast

In the analysis of the trend of change in GDP, the next five years is expected to be positive with an average percentage increase of 2%. From 2015 to 2020, the growth of GDP is expected to be 1.8% in 2016, 2% in 2017, 2.2% in 2018, 2.4% in 2019 and 3% in 2020. This will, make GDP to stand at 18,300 billion dollars. The forecast is based on the trends that have been in existence since 1950.

Also, economists’ claims that savings have an impact on the economic growth and can affect the prices too. The national savings, according to the National Bureau of Economics has been in significant decline since 1960. The national savings dropped to its all-time low level in 2005. In 1990, the savings rate was at 8%. This figure has been in steady decline till it hit negative 2.1 in 2005. However 2010 has shown some improvement, 5%, the rate is still considered to be very low.

Economic forecast on savings

As the trends been, the savings is not expected to be more in five years from now. It is expected to increase slightly for two years and stand at 6% and decline to five percent again in five years time (Hofmann & Bogdanova, 2012). This has been the trend and is still expected to continue. Savings usually help the economy in tough times and can speed up economic recovery after the depression.

Consequently, investment in the United States of America has been on the rise in 1990 especially direct foreign investments. There was about 45% inflow from foreign direct investment to the USA. It can be said to be the many companies from the USA that have branches in several nations across the world. FDI increases GDP and thus influences the economic growth, inflation and in the long run, prices of commodities. According to this trend, the next five years will see the USA having a high percentage change in investments. It is forecasted to increase by 55% by 2020.

Real interest rates in the USA also have experienced significant changes over the period. In 2007, the real interest rate was at 5.25%. Before this, the last time interest rates were above 5% was in the year 2000 at 6.80 percent. Ever since it has been fluctuating between 1% and 4.5% until 2007 when it reached 5.25%. However, the trend went down again, and in 2015, the real interest rate was 2.24%. Every time interest rate changes, there is an impact on the economy. Higher interest rates encourage savings and discourage spending, however when interest rates are low, spending goes up because funds are available and can easily be accessed through borrowing. In the long run, the interest rate affects money supply and circulation which has an impact on prices of commodities. As per the trends, interest rates are forecasted to be at 4.5% by 2020.

Also, the rates of unemployment also affect money circulation which also affects the prices of commodities. The historical view of unemployment in the USA shows that in 1950, the rate was at 3 percent. The highest rate was on 1980 when it hit 10 percent after which it has been in decline. Currently, by 2010 data, the unemployment rate was at 9 percent and 4.7 percent in 2017. In the next five years, there will be no big change in unemployment rate. However, it is prognosticated that it will be a bit high at 6% due to tough economic times.

A government policy influences economic growth in many dimensions. Policy; a policy is defined as a deliberate system of principles to guide decisions and achieve a rational outcome, which is implemented as a procedure or protocol. The policy applies to government, private sector organization, groups and even individuals. Two main policy directions influence appositive economic growth in a country. That is either increase of aggregate supply or aggregate demand. While supply side policies are important in determining the long-run growth in productivity, demand side becomes important during a period of economic stagnation (Tsagkanos & Siriopoulos, 2013). Essentially policies to boost economic growth suggest either an increase in aggregate demand or aggregate supply. Demand side policies become important during a recession or period of economic stagnation. Supply side policies are important for determining long-run growth in productivity. The government can cut interest rate through its monetary policy; this will in return reduce the cost of borrowing thus encouraging investments and consumer spending. When interest is low, incentives to save reduces, this makes spending more attractive, mortgage interest payment, increasing disposable income for consumers, will also reduce as a result of lower interest rate. Amore unconventional monetary policy may be deployed in a case where lower interest rate fails to boost demand. Quantitative easing (increasing the money supply and buying bonds to keep bond rates low), is one method that can be used. This will ensure that interest rates will boost investments and economic activity (Tsagkanos & Siriopoulos, 2013). It’s used to avoid the possibility of inflation that may arise due to increase in money supply.

Monetary policy; a poor monetary policy that ends in high inflation can impede economy in various ways; to begin with, high inflation leads interference of with the ability of relative prices hence providing signals to guide the allocation of productive resources to their highest valued uses. If prices rise simultaneously and uniformly because of inflation, then it wouldn’t affect relative prizes, and the patterns of demand and supply would not be affected however experiences suggest that inflation affects prices differently at different speeds and thus alters prizes and changes production negatively and consumers of goods. Inflation; is described as a continued increase in the general level of prices for goods and services (Tsagkanos & Siriopoulos, 2013). It is measured as an annual percentage increase. By interest rates going down in short -term long-term interest rates go down; it’s cheaper to borrow, so people are more willing to buy goods and services, while firms embark in more production.

Another factor that affects economic growth is the trade deficit. A trade deficit occurs when there is more spending on imports than one received from exports. In contrary to the belief that trade deficits are bad for the economic growth; it was noted in 1980 in the United States that it influenced economic growth by three times faster when deficits were expanding, and as compared to periods when the share of GDP was contracting. The increase in manufacturing output, Increase in the stock market, and the significance of job growth were all noted to be more vibrant during periods of trade deficits expanding imports. Thus, when more goods are being exported, as with any surplus, the U.S. government may buy more of its treasury shares and lower the rate of inflation in the country. The objective of U.S. trade policy should but to maximize the freedom of Americans to trade goods, services, and assets in the global marketplace.

Trade deficit causes unemployment in a country because there are no exports of the goods of that country but more spending on the goods from outside. With unemployment going up, money would not be too much in circulation, and thus prices of commodities would be higher due to reduced demand.

Market for loanable funds

The market for the loanable fund is described as a place where borrowers and savers can set up market clearing quantity price or the interest rates. Loanable funds are mostly cash but can also be said to include other financial assets. For example, when savers buy bonds, the amount in their accounts is transferred to the institution that is issuing the bond. Loanable funds are important in investments where they are used as capital. There are a group of savers and borrowers (Garratt, Lee, Pesaran, & Shin, 2012). This act as fund pooling that can then be used for investment through borrowing.

The importance of the market for the loanable fund is that it makes it easy for the investors to access funds that they can use as capital to start various businesses. This is important for a strategy to increase GDP in an economy. When there is more funds or easily accessible funds for investment, there would be more jobs created by this investments and also there will be more taxes revenue that the government will collect from the said investments and thus significant in the growth of GDP. Employment would be created both by government and individuals as they can borrow money to fund their business or start a new one.

In the long run, there will be the stability in prices of various commodities in the market. The inflation rate will go down due to the high rate of employment, and thus prices of goods will also be stable.

Market for foreign currency exchange

Foreign exchange market is a decentralized market where countries and companies or even individuals can trade currencies. It includes all the activities of buying and selling as well as exchanging currencies or determining the prices of these currencies. The major participants are the international banks as well as financial institutions all over the world. This market has no capacity to establish the values of various currencies but instead, their prices. The foreign exchange market transfer purchasing power from one country to another through foreign bills (Garratt, Lee, Pesaran, & Shin, 2012). The most important function of this market is the provision of credit transfer for international trade.

When countries trade with one another, there is a need for a place where they can exchange their currencies from their trading partner to their home currency. Foreign exchange market provides this avenue and thus facilitates trade among different nations.

Foreign exchange market also hedges foreign exchange risks by different help nations and international financial institution to avoid risks that might come up as a result of foreign exchange. Where there is a change in the value of a particular currency, there would be a gain or loss to a concerned party(Hofmann & Bogdanova, 2012). This can result in a huge financial loss to a country of an organization involved. The foreign exchange market would apply its trading tools to help avoid such huge losses and thus provide benefit to all those involved in the trade. It uses instruments like a foreign bill of exchange, telegraphic transfer, and letters of credits as well as bank drafts. It also offers huge loans into traders involved to boost their investments. The loan is taken as a capital to funds most of the largest infrastructures and other business that needs large funds. This is significant in the promotion of international trade that countries are using to improve their economy through increased GDP and reduced unemployment. When it comes to its relationship with the prices, foreign exchange market will help establish a market for different commodities. It is a tool for money circulation through trade and foreign exchange and thus influences prices in the market.

From the above analysis, various factors affects GDP and money circulation which later impacts positively or negatively on prices in the market. Strategy to control prices and through various policies can be achieved. The government policies such as monetary policy can be helpful in achieving some of this strategy (Hofmann & Bogdanova, 2012). Also creating a market for loanable funds where traders can pool funds together and engage in investment is important in realizing these goals. Moreover, the creation of foreign exchange market and reduction of trade deficits would be helpful as they reduce the rate of unemployment.

References

Garratt, A., Lee, K., Pesaran, M. H., & Shin, Y. (2012). Global and national macroeconometric modelling: a long-run structural approach. Oxford University Press.

Hofmann, B., & Bogdanova, B. (2012). Taylor Rules and Monetary Policy: A Global’Great Deviation’?.

Tsagkanos, A., & Siriopoulos, C. (2013). A long-run relationship between stock price index and exchange rate: A structural nonparametric cointegrating regression approach. Journal of International Financial Markets, Institutions and Money, 25, 106-118.