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Running head: MONEY AND THE PRICES IN THE ECONOMY
Money and the Prices in the Long Run and Open Economies
Name
Institutional Affiliation
1
MONEY AND PRICES IN THE ECONOMY
2
Money and the Prices in the Long-Run and Open Economies
History of changes in GDP
Gross Domestic Product refers to the value of a countryâ??s output. It is usually a measure
of the market value of a countryâ??s final goods and services in monetary value over a period.
Calculation of a countryâ??s GDP involves the addition of consumption to the government
spending, the countryâ??s total investment, and the capital expenditure required. GDP is a measure
of a countryâ??s economic growth, and the value varies according to factors like political stability
and environmental factors among others (Johnson, 2013). America has had one of the most
robust GDP in the world, given its sizeable economic capacity, which goes hand in hand with the
purchasing power of the citizens. Though the country used other measures of economic growth
in the early 19th century, it fully adopted the use of GDP as the only measure of economic value
in the 20th century. Since then, the country has experienced an average GDP of 3.21% up to
date. The highest GDP growth rate in the countryâ??s history was 16.90 percent that America
experienced during the first quarter of the year 1950 (Bernanke, 2010). On the other side, the
nation experienced a record low GDP growth of 10% in the first quarter of the year 1958. Since
then the country has experienced fluctuations of high low GDP growth. The economy grew at a
rate of 2.3% in the year 2017 with a GDP value of $20.2 trillion. The first quarter of the year
2018 also reveals a stable economic growth of 2.3% through the estimate was lower. The rate is
expected to grow by 2% in 2018, 2.4% in the year 2019 and 2% in 2020.
Savings
They refer to the percentage of income not spent by a country. It is also the percentage of
Gross Domestic Product that households of a country hold. The government borrows these
MONEY AND PRICES IN THE ECONOMY
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savings from individuals to finance their activities. Therefore, a higher rate of householdsâ??
savings is equivalent to the financial state and growth of a country. However, America has a lot
of effort to increase the savings of individuals. A recent survey reveals that 21% of Americans
do not have a bank account, while about 67% of the population has less than $1,000 in savings.
In the period between 1959 and 2018, the average of American household savings averaged
8.25% with fluctuations of high and low seasons (National Bureau of Research). The highest
record in household savings was 17% in the year 1975, while the lowest record in the countryâ??s
savings was 1.9% in the year 2005 (Bernanke, 2010). The savings rate dropped from 2.9% in
November, to 2.4% in December 2017. The prices then grew 3.2% in January, 3.4% in February,
and then recorded a drop to 3.1% in March 2018. The savings growth rate in the country is
expected to grow at the same rate of 2.3% over the next five years.
Investment
The value of personal savings equals the value of their investments. People invest in their
savings with the hope of generating a higher income in the form of profits. Investments are
necessary for promoting the countryâ??s economic growth. The value of Americaâ??s savings and
investments has declined significantly over time. However, the global financial crisis is the
primary cause of the decline, because it affected households negatively reducing their productive
capacity. As a result, America has the largest debt capacity in the world. Even private savings in
the country do not grow at a rate that is enough to fund the deficits. The slow growth rate in
Americaâ??s investments cannot keep pace with the countryâ??s depreciation and deterioration of
infrastructure (National Bureau of Research). As a result, America relies on foreign investment
to fund its expenditures. The countryâ??s investments constituted a percentage of 9% of the GDP in
the year 1969 while it has continued the downward trend to less than 4 percent of the countryâ??s
MONEY AND PRICES IN THE ECONOMY
4
GDP in 2018. During the year 2009, the countryâ??s investments hit rock-bottom at about 1% of
the countryâ??s GDP (Bernanke, 2010). One of the causes of low investment rate is the fact that
American consumers are living beyond their means. If this does not stop, then the countryâ??s
investment is likely to fall beyond zero by the year 2022.
Real interest rates
The real interest rate refers to the interest that an investor, lender, or saver receives. It is
necessary to note that this rate considers inflation. It is the nominal interest rate less the rate of
inflation. The regulation of Americaâ??s interest rates is purely the work of the Federal Reserve
through fiscal measures to regulate inflation. Lower interest rates attract borrowing, and
eventually increased investments, while higher prices lead to reduced lending. The Federal
Reserve changes the interest rates according to the prevailing economic condition. Between the
periods 1972 to 2018, the Federal Reservesâ?? interest rates have averaged 5.72 percent (National
Bureau of Research). The interest rates reached a record low in 2008 at 0.25 percent while the
highest ever recorded rate was 20 percent in the year 1980. During the recent meeting of the
Federal Reserve Board, the interest rates were set between 1.5 and 1.75. The interest rates are
expected to rise between 2.1% in the year 2018 and 2.9% in the year 2020.
Unemployment
According to the Bureau of Labor Statistics, unemployment refers to people who are not
currently employed, and that have been actively looking for jobs in the economy. Between the
period 1948 and 2018, the unemployment rate in the United States averaged 5.78 percent. During
this period, the highest percentage of unemployment was recorded at 10.8% in the year 1980,
while the lowest record was set in the year 1953 at 2.50%. In the first quarter of the year 2018,
MONEY AND PRICES IN THE ECONOMY
5
the unemployment rate decreased from 4.1% in May to 3.9% in April (National Bureau of
Research). The unemployment rate in America is expected to decline to 3.8% this year and
stagnate at 3.6% from 2019 to 2022.
How Government Policies Influence Economic Growth
The government controls the economy through the application of monetary and fiscal
policies. Monetary policies refer to the actions of the central bank and other regulatory
committees. These policies target the interest rates, which in turn influence the supply of money
in the economy. When the Federal Reserve increases the interest rates, the circulation of money
in the economy reduces as few people are borrowing (Woodford, 2011). In turn, the level of
investments decreases as high rates discourage spending. The strategy of raising the interest rates
is helpful in reducing inflation in a country. On the other side, when the Federal Reserve lowers
the interest rates, the circulation of money in the economy increases which in turn increases
borrowing and the level of investments.
Fiscal policies refer to the activities of the government to adjust the tax rates and level of
spending to regulate economic growth. Budgetary policies target the aggregate demand of a
country and eventually affect economic development. These strategies impact on economic
growth by growing total demand through increases in spending and lowering taxes (Agnello &
Sousa, 2013). On the other side, it could reduce aggregate demand by increasing taxation and
decreasing government spending.
Impact of Monetary Policies in the Long-Run Behavior
The government uses expansionary policies in three ways: reducing the interest rates,
lowering discount reserve requirement, and Open Market Operations. The impact of monetary
MONEY AND PRICES IN THE ECONOMY
6
policies on the economy in the long-run gives either the price or the income effect. Expansionary
monetary policy by the authorities reduces a countryâ??s interest rates and, in turn, there is
increased supply of money in the economy. People will have a higher incentive to invest while
they will save less. Financial assets including bonds will decrease in value and investors will buy
more in anticipation for future benefits (Bernanke, 2010). Increased rate of investment will, in
turn, lower the price of unemployment in the country. The higher economic growth associated
with high levels of investment will as well drop the rate of inflation in a nation. On the other
side, the contractionary policy aims at reducing the circulation of money in the economy. These
strategies are more or less the opposite of expansionary policies. The Open Market Committee
may raise the federal discount rates as well as sell securities through Open Market Operations.
These policies increase the interest rates which in turn reduce the desirability of customers to
borrow money (Woodford, 2011). In turn, the bond prices go up, and investments will decrease.
The unemployment rate will rise while the rate of inflation increases in the country.
Impact of Trade Deficits or Surpluses on the GDP
Trade deficits and surpluses are measures of a countryâ??s international trade that indicate
the excess value of either imports or exports. A deficit, in this case, is a situation where the
imports exceed the exports while a surplus represents a case in which the export value exceeds
the import value in a country. In the case of a trade deficit, then consumers will spend more on
foreign products compared to the amount that the state sells its domestically produced goods to
foreign countries (Johnson, 2013). Trade deficits usually have adverse effects to the countryâ??s
GDP, especially over a long duration. For one, it may hinder the growth of domestic companies
as there is less consumption of local products. Employment levels may also fall in the local arena
while the foreign markets may provide more job opportunities. Trade deficit impacts negatively
MONEY AND PRICES IN THE ECONOMY
7
on the current accounts balance while it also reduces the balance of payment. The value of the
countryâ??s domestic currency also decreases compared to that of the foreign money. As a result,
the nation relies significantly on foreign debt which is payable at an interest. If the debt escalates
to higher levels, it may result in a currency crisis that will hinder economic growth.
A trade surplus on the other side represents a favorable balance of trade. Because the
country sells more goods than it buys from outside, the current account has more money. As a
result, it is possible to purchase assets from other countries and as a result, financing the debt and
also offers a degree of political influence. When the state has more money, then the investments
increase which increases employment in the country. In the long-run, the surplus in the trade
leads to increased GDP which is an indicator of economic growth.
Importance of Market for Loanable Funds and Foreign Currency Exchange
The demand for loanable funds and foreign currency exchange is of concern to foreign
investors. The prices of loanable funds are one of the determinants of the real interest rates.
Banks make their profits through investing in clientsâ?? deposits. In this case, when a client seeks a
loan from the bank, the bank imposes an interest rate on the repayment value. This interest rate,
therefore, influences the rate at which the borrowed money grows and thereby influencing the
countryâ??s inflation (Johnson, 2013). Countries investing in foreign land, therefore, need to
determine the interest rates of the destination countryâ??s loanable funds. An attractive country of
destination is one which offers low-interest rates on funds to attract borrowing. Lower rates of
interest on funds are not only beneficial to the borrower but also to the lender since the country
will borrow large amounts of money for development projects which borrowers will pay back
with interest. In the long-run, this will generate economic growth. Foreign exchange markets
MONEY AND PRICES IN THE ECONOMY
8
involve the countriesâ?? purchasing power as well as their credit capacity both locally and
internationally (Johnson, 2013). These markets provide the means by which a country exchanges
its currency for another. As a result, it is possible to reduce the currency risk by clearing the
existing debts. Countries can improve their competitive position by maintaining the superiority
of their currency like in the case of the American dollar. Borrowers will have to part with more
money in the loan repayment. A countryâ??s strategic plan regarding international trade involves
increased economic growth and increased productivity.
Recommendations on Strategic Management
A strategic plan regarding international trade is achievable if the government sets up
strategies to control trade like tariffs, quotas, taxes, volume limitations and foreign capital. A
thorough examination of the countryâ??s economy is required as well as the availability of capital
whether through loanable funds or a countryâ??s savings. If a nation purposes of increasing its
productivity, then it must develop strategies that strengthen its local currency such that it attracts
investors. A balance of trade is a requirement in the development of procedure because it
represents the readiness of the market. Any strategic plan is achievable based on the policies
involved as well as the duration of which the country hopes to achieve them.
References
Agnello, L., & Sousa, R. M. (2013). Fiscal policy and asset prices. Bulletin of Economic
Research, 65(2), 154-177.
MONEY AND PRICES IN THE ECONOMY
9
Bernanke, B. S. (2010). Opening remarks: the economic outlook and monetary policy. In
Proceedings-Economic Policy Symposium-Jackson Hole (pp. 1-16). Federal Reserve
Bank of Kansas City.
Johnson, H. G. (2013). Towards a general theory of the balance of payments. In International
Trade and Economic Growth (Collected Works of Harry Johnson) (pp. 153-168).
Routledge.
Woodford, M. (2011). Interest and prices: Foundations of a theory of monetary policy. princeton
university press.

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