Example Of Macroeconomics Case Study

The themes of the two articles focused on the two Central Banks’ (the Federal Reserve and the European Central Bank) attempts to stimulate their respective economies through the use of ‘unconventional’ monetary tool (i.e., open-ended bond purchases to drive down the interest rates also known as quantitative easing). Though the Fed and the ECB have used the same monetary tool to affect economic activity, the goals were different: the Fed aims to boost the economy’s output while the ECB aims to save the euro.
I am interested in exploring how monetary policy affects the economic activity of a country. The Central Bank has three conventional monetary tools at its disposal, namely buying/selling of government bonds through open-market operations, imposing minimum reserve ratio to banks, and the discount rates. The Central Banks often use the open-market operation to alter the monetary base and thus, the money supply. How will the change in money supply results to a change in the rate of interests? According to the theory of liquidity preference, changing the money supply (supply of real money balances) alters the interest rate. Specifically, the Central Bank’s buying of bonds from the public increases the real money balances, resulting to the increase in money supply (shift of the supply curve to the right). This leads to the fall in the rate of interest.
A different scenario happens when Central Banks use quantitative easing. This unconventional monetary tool works in two ways, theoretically. First, the Central Bank’s purchasing of financial assets from private institutions like commercial banks using newly created money results to increases in the excess reserves of banks. This in turn makes financial assets’ price to rise and the yield to fall. The graph below further supports this analysis. The expected return on bonds is equal to its yield to maturity and is given by the equation: i=Rete=(F-P)/P. Suppose the face value of the bond is $2000, with 1 year maturity. Computing for the expected return at various prices gives the following values:
Second, buying of financial assets by the Central Bank from the commercial banks increases the bank’s cash available money for lending. Increase in the supply of loanable funds decreases the interest rate of borrowing that tends to encourage investment activity in the economy.
Looking at the big picture, using the quantitative easing is obviously aimed at increasing lending and spending by the public. As what Keynes said, lower interest rate stimulates borrowing of the private sector for investment. In turn, increases in investment spending results to increase in the aggregate demand that leads to increases in national output (that is more than the increase in aggregate demand because of the multiplier effect).