02 Feb Trade balance affects

GB540 Economics for Global Decision Makers

Unit 6 discussion

DQ1 Monetary Policy

The Federal Reserve is responsible for regulating the U.S. monetary system and setting monetary policy. Monetary policy refers to what the Federal Reserve does to influence the amount of money and credit in the U.S. economy. Policy instruments that affect quantity of money and credit affect interest rates (the cost of credit) and the performance of the U.S. economy.

The Federal Reserve’s three instruments of monetary policy are open market operations, the discount rate and reserve requirements. The Fed controls the money supply primarily through open-market operations.

Board of Governors of the Federal Reserve System. (n.d.). Retrieved from http://www.federalreserve.gov/

Based on the above summary and the detailed descriptions of the monetary policy issues in the textbook (Chapter 34) discuss the following questions.

What are the expansionary monetary policy and contractionary monetary policy? What are their policy instruments? How are they used to deal with the inflationary gap and recessionary gap? Which do you think is more appropriate today?

If the Fed wants to increase aggregate demand, it can increase the money supply. If it does this, what happens to the interest rate and rate of inflation? Why might the Fed choose not to respond in this way?

Should monetary policy be made by rule rather than by discretion? Why?

The only thing backing up a nation’s currency (fiat money) in the modern world is faith in the government issuing it. If this is so, what should governments do to maintain a stable currency? How can the Central Bank (the Federal Reserve) build trust in the U.S. currency? What actions would undermine a currency?

DQ2 Trade Balance and Exchange Rates

A balance of trade (trade balance) is the difference between the monetary values of exports and imports of a country’s economic output over a given period of time. Trade balance can be positive (favorable) when the value of exports is greater than the value of imports. The positive trade balance is also called trade surplus. On the other hand, if the value of imports is greater than the value of exports, the trade balance indicates trade deficit.

Trade balance affects the Gross Domestic Product (GDP) of a country because net export is a component of the GDP. Recall GDP = C + I + G + Nx

Trade balance also affects the exchange rate of a country’s currency. Supply and demand for foreign currency result in changing prices of a currency. The price of a currency changes as demand for a foreign currency changes.

Based on the above summary and the detailed descriptions of the balance of payments, exchange rates and trade deficits issues in the textbook (Chapter 39) discuss the following questions.

Is it trade deficit or trade surplus that contributes more to economic growth? Why?

What are the factors that increase and decrease the demand for a foreign currency?

What are the impacts of currency devaluation and revaluation on international trade?

What is currency war? How does it affect trade between countries?