Read Chapter 36 (Interest Rates and Monetary Policy)
and use the youtube videos to answer the question .
1. List AND explain the three (3) uses of Money. .
2. List AND explain the four (4) characteristics of Money.?
3. List AND explain the three (3) things money needs to have value.?
4. Explain what the Laffer Curve is AND why it is important?
5. Explain contractionary fiscal policy, including when it should be used, what tools are used, and how those tools are used.
6. Calculate the deficit or surplus for each year using the following information:
Year Expenses Revenues Deficit/Surplus
1989 $900 billion $1.2 trillion
1990 $1.3 trillion $1.3 trillion
1991 $1.5 trillion $1.2 trillion
1992 $1.6 trillion $1.8 trillion
1993 $2.1 trillion $1.3 trillion
7. Using the deficit and surplus information in question 6 above, what is the debt in this country at the end of 1993?
8. Explain AND give an example of crowding out.
9. Explain and give an example of being able to manage the $29 trillion debt today.
10. Explain why the expansionary policy has a better chance of working than does contractionary policy.
11. What would you use to nudge the economy away from the inflation zone and into the invisible hand zone AND why it probably not work.
MP Chapter Name: _______________ Date: _____________________
Author’s Name
Professor’s Name
Course Number
Date of Submission
Interest Rates and Monetary Policy
- List AND explain the three (3) uses of Money.
- Money is a store of value – since money can buy just about any item, holding on to it is like holding the value of that item without experiencing losses of value maybe through rotting, breakages, and so on. This store is more liquid and portable than other stores of value like land.
- Money is a unit of account – it is used for measuring the value of goods and services in economic transactions. For instance, it’s understandable to say a computer costs $200 rather than 200 bushels of corn.
- Money is a medium of exchange – this is the most important function of money. Barter trade becomes the next alternative if money is not involved – with a lack of universality as its limitation.
- List ANDexplain the four (4) characteristics of Money?
- Durability – money can last for a long time without losing value, and if it gets worn out, it can be easily replaced. Unlike other goods like oranges or a cow which go bad or get sick respectively.
- Portability –money can easily be carried around or transported unlike other goods of equal value like a cow
- Divisibility –money can easily be broken down into smaller values. For example, a 20-dollar bill broken into 10, a 5, four 1s, and 4 quarters. Unlike goods like a cow, which is a whole animal and can only be divided if dead.
- Acceptability – money is universal and can be accepted by anyone unlike other goods and services that one person might need and the other reject.
- List ANDexplain the three (3) things money needs to have value?
Money gets its value from exchange rates, the demand for the treasury notes, and the foreign exchange reserves.
- Exchange rates determine the price of a dollar in foreign currency, done by forex traders after considering its supply and demand, and future expectations.
- The value of Treasury notes accounts for the ease of converting a currency into dollars through the secondary market for Treasuries. The higher the demand in the Treasury the more valuable the currency.
- Foreign exchange reserves define the number of dollars held by foreign governments. Holding more money limits supply, increase demand, and makes a currency more valuable.
- Explain what the Laffer Curve is AND why it is important?
The Laffer Curve is a theory developed by economist Arthur Laffer to demonstrate how the amount of tax revenue governments collect relate to tax rates (McConnell et al., 780). The curve supports arguments that lowering tax rates can sometimes increase the total tax revenue. This is because low tax rates stimulate economic incentives and increase tax revenue.
- Explain contractionary fiscal policy, including when it should be used, what tools are used, and how those tools are used.
The contractionary fiscal policy defines a situation in which the government reduces spending or the rate of monetary expansion by the central bank to counter rising inflation. In case a government intervention or central bank creates any economic distortion, Contractionary fiscal policy helps address them. Contractionary fiscal policy is used when there is extreme inflation or when a prior expansionary policy has led to increasing speculations and capital investments (McConnell et al., 666). To implement the Contractionary fiscal policy, governments mostly use two tools – taxation and spending. These tools are used by collecting more money in the tax revenue and spending less of it (McConnell et al., 723). Spending is reduced, taxes are increased, or a combination of the two can be used.
- Calculate the deficit or surplus for each year using the following information:
| Year | Expenses | Revenues | Deficit/Surplus |
| 1989 | $900 billion | $1.2 trillion | $300 billion |
| 1990 | $1.3 trillion | $1.3 trillion | 0 |
| 1991 | $1.5 trillion | $1.2 trillion | $-300 billion |
| 1992 | $1.6 trillion | $1.8 trillion | $200 billion |
| 1993 | $2.1 trillion | $1.3 trillion | $ -800 billion |
- Using the deficit and surplus information in question 6 above, what is the debt in this country at the end of 1993?
Debt = surplus – deficit
Surplus = $300+$ 200 billion = $500 billion
Deficit = ($-300+-800) = -1.1 trillion
Debt = $500 billion- $1.1 trillion=$ -600 billion (deficit)
Debt = $-600 billion.
- Explain AND give an example of crowding out.
Crowding out is an economic theory that holds that an increase in interest rates results in a decrease in the initial private investment spending (McConnell et al., 671). Examples of crowding out include an increase in borrowing, increase in tax, fiscal, physical, and financial.
- Explain and give an example of being able to manage the $29 trillion debt today.
An example is how governments currently operate. Governments borrow money and issue bonds to avail money for covering expenses and avoid unnecessary rises in taxes. If necessary, the government will increase taxes such as federal taxes, sin taxes, business tax, and local income tax to pay for expenditure (McConnell et al., 719).
- Explain why the expansionary policy has a better chance of working than does the contractionary policy.
Unlike contractionary policy, the expansionary policy increases spending and lowers taxation, thereby expanding money supply (McConnell et al., 729). Consequently, expansionary policy increases demand for goods and services and expand profitability as opposed to the contradictory policy.
- What would you use to nudge the economy away from the inflation zone and into the invisible hand zone AND why it probably not work.
There are many options to choose from to achieve this. For instance, I can enhance withdrawal recovery by increasing the reserve requirements on the money normally kept in banks. I can enact policies aimed at decreasing money supply to reduce the supply of money (McConnell et al., 738). Additionally, I would increase interest rates by the use of monetary policies or decrease bond prices to reduce money supply within the economy. These options have always been proposed to implement nudges though their feasibility is never certain because they are considered unethical and hard to implement (McConnell et al., 103). With a nudge, the government tends to over-extend control on people’s behavior and deny them their freedom of choice. It is hard to control people’s behavior, and it is unethical the deny people their freedom of choice.
Works Cited
McConnell, Campbell R., Stanley L. Brue, and Sean Masaki Flynn. Economics: Principles, problems, and policies. New York: McGraw-Hill/Irwin, 2005.