Long-term influence of monetary policy
Monetary policy can either be contractionary or expansionary, and both policies impact nominal variables differently in the long-run.
Price levels
A contractionary policy results in a decrease in equity prices because the income stream is discounted at a relatively higher rate. Also, the price levels of equity can drop since high-interest rates and low supply of money lead to reduced demand for equity. In this case, bonds can be an attractive investment since they pay high interests (Meltzer, 1995). Nevertheless, an increase in interest rates does not always result in fall of share prices. People may interpret the high-interest rates as an indication that the Federal Reserve predicts a faster economic growth in the future. Consequently, a rise in interest rates might result in an increase in equity prices since people expect high profits in the future.
Inflation rates
Importantly, monetary policy is a key factor that results in a rise in inflation. Low-interest rates inspire people to borrow and consequently increase the demand for goods and services. When the demand is relatively higher than the firm’s capacity to produce products and services, the businesses react by raising the prices, which result in inflation in the long-run. Further, spending on goods and services triggers high inflation rates. This aspect will force the Federal Reserve to take necessary actions to control the flow of funds in the economy.
Costs
A contractionary policy impacts borrowing costs adversely. In long-term, the costs of borrowing will be high since interest rates tend to rise. Nevertheless, the impact of the policy on interest rates may not necessarily impact costs of borrowing. A higher policy rate may lead to decrease or increase in interest rates in the long-term subject to the prevailing and anticipated future short run interest rates (Pétursson, 1998). Hence, the market prediction of future changes on the short-term interest rates is very vital in determining the costs on long-run. The anticipation is mostly on future inflation, which is a primary influencer of interest rates. For instance, if people predict low short-run rate in the future, a policy rise may trigger a fall in the long-term interest rates.
Exchange rates
An expansionary monetary policy results in a decrease in real interest rate. Low-interest rates discourage foreign investment, which decreases the demand for the country’s currency and increased demand for foreign currency. That results in a decline in the country’s exchange rate in the long-term. Conversely, a restrictive monetary policy increases the demand for the nation’s currency, which consequently results in an increase in exchange rate.
Wages
The monetary policy may impact the level of salaries adversely or positively in the long run. An expansionary policy may encourage firms to increase wages since they have a lot of disposable money. On the other hand, a restrictive policy may lead to constant or even lower salary levels. Ideally, when the flow of money in the economy is low, employers will not be willing to offer high wages.
Influence of monetary level on real variables
According to Patinkin (1987), monetary policy has no impact on real variables such as job creation, and real GDP. This view draws from classical economics, which holds that a decrease or increase of money in the economy leads to an increase in salaries and price levels. Thus, monetary policy will not impact the real economy in the long-run.
Influence of trade deficits on the growth of productivity and GDP
Long-term trade deficit might have adverse impacts on the productivity and GDP. A nation may fall into debts if its import is higher than the export. A long-term surplus results in a decline in domestic spending, which in turn, harms local producers. In this case, investors may be reluctant to invest domestically and turn to foreign stock markets. A continuous increase in trade deficit may lower productivity, which consequently leads to job loss. A high rate of unemployment reduces production activities in a country. For instance, between 2001 and 2003, the United States manufacturing industry dropped about 2.4 million jobs due to its trade deficit (Scott, 2003). Further, loss of employment may happen when investors shift production services to other countries that have a low trade deficit. In the U.S., NAFTA enhanced the flow of work out of the country since it encouraged companies to shift their manufacturing activities to Canada and Mexico. Notably, United Stated lost thousands of jobs due to the NAFTA deficit (Scott, 2003). That led to an increase in income inequality and stagnation in the living standards.
The trade deficit also has a depressing impact on wages, in various ways. Macroeconomic policies including interest rates and federal expenditure have a greater impact on the employment compared to the effect of trade. However, trade affects the composition of employment. Ideally, employees who do not work in manufacturing industry search for jobs in other industries in the long run, mainly in the service sector. Additionally, trade deficit impacts business competitiveness in the long term. The demand for a country’s products in foreign markets declines steadily, affecting the productivity and GDP adversely. Moreover, the surplus tends to lower investment in R&D, which undermines productivity of the country.
a. Significance of the market for loanable funds
Loanable funds comprise the money that organizations and people save to lend out to other entities for investment. The market for loanable funds includes individuals and businesses who are seeking money to invest. The availability of a market for loanable funds means that companies are willing to invest in assets or working capital. On the other hand, individuals form a market for loanable funds if they want to invest in homes or business. The market for loanable funds will promote the achievement of strategic plans since the funds will earn interest. High demand for loanable funds will increase the supply and interest rates. In this case, the cost of the loanable funds will be high, which results in higher returns. However, a steady increase in the interest rates will lower the market of the funds. After some time, the supply and demand of loanable funds will be equal; at this point, the interest rate of the loanable funds will be at equilibrium (Howrey and Hymans, 1978).
b. Importance of the market for foreign-currency exchange
Foreign currency exchange markets allow the trade of currencies of different countries. Lander and Preece (2014) assert that the market for foreign-currency exchange is vital since it supports the foreign investments and global trade. This market if fundamental since it supports exports and imports, which are essential to acquire inputs and develop more demand for products. Lack of the market for foreign currency would hinder the achievement of the strategic plan since it would limit access to resources. Importantly, the market would allow global diversification which permits the company to extend into the foreign markets. Also, it will allow the company to trade currencies as it strives to purchase and vend securities and assets.
References
Howrey, E. P., & Hymans, S. H. (1978). The Measurement and Determination of Loanable-Funds Saving. Brookings Papers On Economic Activity, (3), 655-685.
Lander, K., & Preece, R. (2014). Finance briefing: Foreign exchange market and why it matters. . Retrieved July 18, 2016, from <http://www.ft.com/cms/s/0/a3b9e74c-ba6f-11e3-aeb0-00144feabdc0.html#axzz4EkD23Ne4s>
Meltzer, A. H. (1995). Monetary, credit and (other) transmission processes: A monetarist perspective. Journal of Economic Perspectives, 9(4), 49–72.
Pétursson, T. G. (1998). Explaining the term structure: The expectation hypothesis and time varying term premia. University of Iceland Institute of Economic Studies.
Patinkin, D. (1987). Neutrality of money. The New Palgrave:A Dictionary of Economics, 3(1), 639-44.
Scott, R. E. (2003). The high price of “free” trade: NAFTA’s failure has cost the United States jobs across the nation. Retrieved July 18, 2016, from <http://www.epi.org/publication/briefingpapers_bp147/>
