Table of Contents

Table of Contents ............................................................................................................. 1 Introduction ...................................................................................................................... 2 Goal of Monetary Policy .................................................................................................. 6 Factors considered by the Monetary Policy ................................................................... 10 Factors of Monetary Policy and its effect on Macroeconomics ..................................... 13 Conclusion ...................................................................................................................... 15 Reference ........................................................................................................................ 18 Coursework..................................................................................................................... 19

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Introduction
In modern years, the subject of economics is divided into two broad areas. One of them is called Microeconomics and the other is called Macroeconomics. These two terms microeconomics and macroeconomics were first coined and used by Ranger Frisco in 1933. In recent years, division of economic theory into two separate parts has gained much importance. Microeconomics is a Greek word which means small. Microeconomics is the study of specific individual units; particular firms, particular households, individual prices, wages, individual industries particular commodities. The microeconomic theory or price theory thus is the study of individual parts of the economy. For instance, in microeconomic analysis we study the demand of an individual consumer for a good and from there we go to derive the market demand for a good (that is demand of a group of individuals for a good). In the words of Samuelson: Microeconomics we examine among other things how individual prices are set, consider what determines the price of land and capital and enquire into the strength and weaknesses of market mechanics .In the words of Leftwitch: Microeconomic theory or price theory deals with the economic behaviour of individual decision making units such as consumers, resources owners, business firms as well as individuals who are too small to have an impact on the national economy. The microeconomic theory takes the total quantity of resources as given. It seeks to explain how they are allocated to the production of goods. The allocation of resources to the production of goods depends upon the price of various goods and the prices of factors of production.

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Microeconomics analyses how the relative prices of goods and factors are determined. Thus the theory of product pricing and the theory of factor pricing (rent wages, interest and profit) fall within the domain of micro economics. The microeconomic theory seeks to explain whether the problems of scarcity and allocation of resources so determined are efficient. Economic efficiency involves (a) efficiency in consumption (b) efficiency in production and distribution and (c) overall economic efficiency. The price theory shows under hat conditions these efficiencies are achieved. The importance and uses of micro economics is helpful in understanding the working of private enterprise economy. The micro economics helps us to understand the working of free market economy. It tells us as to how the prices of the products and the factors of production are determined. The importance and uses of micro economics is helps in knowing the conditions of efficiency. Micro economics help in explaining the conditions of efficiency in consumption, production and in distribution of the rewards of factors of production. The importance and uses of micro economics is working economy without central control. The micro economics reveals how a free enterprise economy functions without any central control. The importance and uses of micro economics is study of welfare economy. Micro economic involves the study of welfare economics. Microeconomics despite its many advantages is not free from limitations. They in brief are assumption of full employment in the economy which is unrealistic, assumption of liaises fair policy which is no longer in practice in any country of the world and it studies part of the economy and not the whole. The term macro is derived from the Greek word uakpo which means large. Macroeconomics, the other half of economics, is the study of the behaviour of the economy as a whole. Macroeconomics deals with total or big aggregates such as national income, output and employment, total consumption, aggregate saving and aggregate investment and the general level of prices". In the words of Boulding: Macroeconomics deals not with individual quantities as such but with aggregates of these quantities, not with individual i.e., but with the national Income, not with individual prices but with the price level, not with Individual outputs but with the national output. It studies determination

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of national output and its growth overtime. It also studies the problems of recession, unemployment inflation, the balance of international payments and the policies adopted by the governments to deal with these problems. Macroeconomics helps understanding determination of income and employment. Late J.M. Keynes laid great stress on macro-economic analysis. In his revolutionary book, General Theory, Employment interest and Money" brought drastic changes in economic thinking. He explained the forces or factors which determine the level of aggregate employment and output in the economy. Macroeconomics helps determination of general level of prices. Macroeconomic analysis answers questions as to how the general price level is determined and what is the importance of various factors which influence general price level. Macroeconomics influences the economic growth. The macroeconomic models help us to formulate economic policies for achieving long run economic growth with stability. The new developed growth theories explain the causes of poverty in under developed countries and suggest remedies to overcome them. Macroeconomics helps in business cycles. It is in terms of macroeconomics that causes of fluctuations in the national income are analyzed. It has also been possible now to formulate policies for controlling business cycles i.e. inflation and deflation. Macroeconomics helps international trade. Another important subject of macro-economics is to analyze the various aspects of international trade in goods, services and balance of payment problems, the effect of exchange rate on balance of payment etc. Macroeconomics helps income shares from the national income. Mr. M. Kalecki and Nicholas Kelder, by making departure from Ricarde theory, have presented a macro theory of distribution of income. According to these economists, the relative shares of wages and profits depend upon the ratio of investment to national income. Another macroeconomic issue is to explain the causes of unemployment in the economy. Stagflation is another important issue of modern, economics. The Keynesian and post Keynesian economists are putting lot of efforts in explaining the causes of cyclical unemployment and high unemployment coupled with inflation and suggesting remedies to counteract them. Fiscal and

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monetary policies affect the performance of the economy. These two major types policies are central in macro economic analysis of the economy. In macro economic analysis, it is emphasized that a nations economy is a part of a global economic system. A good or weak performance of a nations economy can affect the performance of the world economy as a whole. The main limitations of macro economics are as follows: The macro economies ignore the welfare of the individual. For instance, if national saving is increased at the cost of individual welfare, it is not considered a wise policy. The macro economics analysis regards aggregates as homogeneous but does not look into its internal composition. For instance, if the wages of the clerks fall and the wages of the teachers rise, the average wage may remain the same. It is not necessary that all aggregate variables are important. For instance, national income is the total of individual incomes. If national income in the country goes up, it is not necessary that the income of all the individuals in the country will also rise. There is a possibility that the rise in national income may be due to the increase in the incomes of a few rich families of the country.

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Goal of Monetary Policy

The monetary policy of the United States is the key to macroeconomic factors such as GDP, unemployment, inflation and interest rates. The government has various options it can go with in order to control the economy the way it sees fit. Budget cuts are one way and another way is selling and buying its own bonds. The other issue that will be discussed in this paper is how money is created and there are two ways for that to happen, one is by borrowing and spending. The other is it is printed by a central bank (Benson, 2004). This paper will discuss why money is printed, for what purposes and how if affects the economy. The monetary policy affects interest rates in that government raises or lowers interest rates in order to have an influence on the demand of goods and services from both companies and the general public (Federal Reserve Bank of San Francisco , 2007). The demand for products is based on real interest rates, which are nominal interest rates minus the rate of inflation. The Federal Reserve Bank of San Francisco gives an example of how it will affect a potential borrower of a car loan. "For example, a borrower is likely to feel a lot happier about a car loan at 8% when the inflation rate is close to 10% (as it was in the late 1970s) than when the inflation rate is close to 2% (as it was in the late 1990s). In the first case, the real (or inflation-adjusted) value of the money that the borrower would pay back would actually be lower than the real value of the money when it was borrowed. Borrowers, of course, would love this situation, while lenders would be disinclined to make any loans." In other words the real interest rate in the former scenario is two percent, while in the latter it is eight percent, which makes the former situation better for the person borrowing the car and worse for the bank giving out the loan. The main tool of monetary policy that the Federal Reserve of the United States uses is Open Market Operations, which is buying and selling government securities among other financial instruments. (Wikipedia, 2008)

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Monetary policy affects inflation in that if the policy "stimulates aggregate demand enough to push labor and capital markets beyond their long-run capacities," then prices of goods and products will be raised. (Federal Reserve Bank of San Francisco, 2007) The Federal Reserve Bank also said that an attempt to keep short term rates down will lead to higher inflation and nominal interest rates that will occur without the growth of production or an increase in employment. Production and employment cannot be influenced in the long run by monetary policy. (Federal Reserve Bank of San Francisco, 2007) People's expectations of monetary policy also affect inflation, if people and businesses believe that inflation rates will be higher in the future (which they would if the Federal government "eased" monetary policy), then they would ask for an increase in both wages and prices. That would also raise inflation without any changes in employment and production. (Federal Reserve Bank of San Francisco, 2007) As mentioned earlier monetary policy cannot directly affect employment in the long-term. In the short term, there is a trade-off between higher inflation and unemployment, but it does not last (Federal Reserve Bank of San Francisco, 2007). However that is only one view of the situation, according to research done by the Economic and Social Research Council, monetary policy does affect unemployment rates (Gammon, 2004) and the larger economic community should realize it and take note. Studies carried out economic scholars seem to indicate that when monetary polices are designed to control inflation, the rises in wages are not good for employment. (Gammon, 2004) If the research cited is correct as opposed to the believes of organizations such as the Federal Reserve Bank of San Francisco, it would be in the best interest of union heads and workers for the government to seek to control inflation. A quote from Professor Christopher Martin regarding his research into monetary policy and unemployment, specifically a concept known as the "aggregate demand effect" states "This effect can be demonstrated through monetary policy that seeks to stabilize employment levels by increasing the money supply - which offsets higher prices - it actually helps keep employment levels stable throughout the economy. By contrast, if price levels are stabilized by reducing the money supply,

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then the reduction in employment is intensified - people loose [sic] their jobs." (Gammon, 2004) It is tough to analyze how much monetary policy affects unemployment, except to say that it affects it to some extent. Many analysts believe it is only short-term, while there is evidence that it could be what drives the unemployment rate in the United States. GDP is affected positively by simulative monetary policy, which is a higher rate of moneysupply expansion. (A Case Study: The Federal Reserve System and Monetary Policy,) The more value goods and services have in a given year, the more the GDP is (McConnell and Brue, 2004). With that said it is imperative for the economy to be active in terms of people working and producing goods in order for GDP to rise. That's why it is so is so important that employment rates stay at a strong level and that people are spending money on products produced. It is also why cuts in the budget negatively affect GDP, because budget cuts increase unemployment, which makes it tougher to produce goods. Of course the government has to be careful because there are "goods" that are harmful to society that count as positives for GDP such as a rifle (McConnell and Brue, 2004). The best way to balance economic growth, low inflation and a reasonable unemployment rate is first to realize that the most important thing for society overall is to lower inflation and at the end of the day, the best one can hope for is that unemployment rates are steady as opposed to higher than normal. Striking a balance between low inflation and low unemployment rates is very difficult. Here is an example, increasing the supply of money will lower the costs for borrowing money, which leads to the increase of the demand for many goods, which lowers the unemployment rate. That all sounds desirable, until eventually the prices of said goods rise and the cost of labor also rises, which leads to the cost of borrowing rising. (Nelson, 2005) So eventually the increase of the supply of money leads to higher prices which are not good for the consumer and at best it has a zero effect if said consumer is also working because of the demand for those goods. Reducing inflation at the expense of short-term strong employment rates is worth it, especially if one believes the majority of financial analysts that employment rates will only be good in the short term with the rise of inflation. So the best

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thing to focus on is the reducing of inflation and the best way to do that is reduce the reserves of commercial banks. That means selling government bonds in order to slow down the economy (investorwords, 2008). As stated, if you believe that monetary policy only affects unemployment in the short term, then reducing inflation will not have a negative affect on the employment rates. We as a society have to hope that other factors will help employment rates. As far as what selling government bonds will do to the economy, it will slow down spending, because it is not as easy to borrow. With that said, the general public will still spend money on necessary things like housing, food and electricity. If lowering inflation means people have to think more about what they buy, while that is not an ideal situation (especially for firms that sell luxury items), it is not as bad as having the prices of said items being so high that it is also a deterrent for potential consumers. In other words high inflation is a bigger deterrent for the consumer then any other variable so that's the most important thing to control. Not everyone agrees with that solution/analysis, there are some economic analysts that suggest that high inflation now is worth it to keep people spending money long term (Benson 2004). According to Benson's Money Created out of Thin Air, money is created by borrowing and spending or by being printed out of "thin air" by a central bank. Most money is created by borrowing and spending in the private sector. (Benson, 2004) When it comes to the central bank printing money that is done by buying government debts or other assets. Money creation benefits financial assets and housing the most (Benson, 2004). Its biggest drawback is that it increases spending, which increases inflation.

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Factors considered by the Monetary Policy

Before each meeting of the Monetary Policy Committee, a huge raft of economic information is put before members of the MPC rate-setting board. Much of the data that is considered will be information that you may have become familiar with during your AS and A2 economics courses. The economic data considered each month by the MPC includes the following: GDP growth and spare capacity: The rate of growth of real national output and the estimated size of the output gap are central to discussions within the MPC about setting the appropriate level of interest rates. Their main task is to set monetary policy so that demand grows more or less in line with the increase in the countrys productive potential.

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MPC considered also bank lending and consumer credit figures including the levels of mortgage equity withdrawal from the housing market and also monthly data on credit card lending. Equity markets (share prices) and house prices - both are considered important in determining household wealth which then feeds through to borrowing and retail spending. The state of play in the UK housing market has been influential in shaping interest rate decisions over the last two to three years although we must remember that the monetary policy committee has no official target for the annual rate of house price inflation. Consumer confidence and business confidence indicators confidence surveys are thought to provide useful advance warning of possible turning points in the economic cycle. So for example, a sharp dip in consumer optimism might herald a retrenchment of spending which could lead to slower GDP growth and a weakening of inflationary pressure. The growth of wages, average earnings and unit labour costs in the labour market these are considered important as indicators of demand pull and cost push inflationary pressure. The Monetary Policy Committee might become concerned if the annual rate of wage inflation surged above the 5% mark as this might eventually feed through into a rise in consumer prices. Unemployment figures and survey evidence on the scale of shortages of skilled labour these are also labour market indicators as was mentioned in the last bullet point. MPC also considered Trends in global foreign exchange markets for example the trend in the value of sterling against the Euro or the US dollar. A weaker exchange rate could be seen as a threat to inflation because it raises the prices of imported goods and services. Forward looking indices such as the Purchasing Managers Index and quarterly surveys of business confidence including data from the Confederation of British Industry and the British Chambers of Commerce

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MPC considered International economic data including recent macroeconomic developments in the twelve member nations of the Euro Zone and the worlds largest economy, the United States too.

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Factors of Monetary Policy and its effect on Macroeconomics

Unemployment: Lowering the interest rate is seen as one method of combating high unemployment. In theory, lower interest rates provide businesses with easier access to credit by virtue of the lowered cost of borrowing money. Businesses use these loans to grow, thereby hiring more workers to fill the need. This hiring spree, in turn, improves the unemployment rate. However, lowering interest rates is ineffective at boosting the employment rate if businesses cannot receive a loan due to poor credit or if financial institutions are especially risk-averse. Foreign Trade: Monetary policy affects trade activity. When monetary policies cause the dollar to grow weaker, imports become more expensive in the United States. On the other hand, domestic firms sell more goods overseas because the price of US goods and services are cheaper. One way the Fed strengthens or weakens the dollar is through the deposit multiplier that determines how much money banks can lend based on the amount of their deposits. If, for instance, the deposit multiplier is 10, the bank may lend $100 with just $10 in deposits. Allowing banks to hold less money in deposits to loan out money increases the dollars in circulation and weakens currency. A strong currency -- caused by reductions in the money supply -- has benefits too. A strong currency makes goods bought from overseas cheaper. However, Peter Montiel, author of "International Macroeconomics" states that a strong currency makes it harder for nations to achieve high employment and output levels. Inflation: Prices of domestic goods and services rise or fall based on monetary policies. Prices rise when the Fed increases the money supply by lowering the interest rate or buys assets as part of a quantitative easing program. When more money is in circulation, consumers need more dollars to purchase things. William Baumol, author of "Economics: Principles and Policy," explains the Fed

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faces a Catch-22 when lowering interest rates -- while this action boosts the unemployment rate, a consequence is inflation, or rising prices. Production and Consumption: Monetary policies affect production and consumption in a number of ways. When investors believe a policy will make the economy worse off, this is reflected in a dip in the stock market. A plunge in the stock market lowers consumer confidence and therefore reduces consumption. When consumers buy fewer goods and services, producers earn less money. This reduction in profit may result in layoffs, which perpetuates a vicious cycle of lowered production and consumption.

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Conclusion
There are many advantages of monetary policy. Transaction costs will be eliminated. For instance, UK firms currently spend about 1.5 billion a year buying and selling foreign currencies to do business in the EU. With the EMU this is eliminated, so increasing profitability of EU firms. Advice to young people: You can go on holiday and not have to worry about getting your money changed, therefore avoiding high conversion charges. Price transparency. Eu firms and households often find it difficult to accurately compare the prices of goods, services and resources across the EU because of the distorting effects of exchange rate differences. This discourages trade. According to economic theory, prices should act as a mechanism to allocate resources in an optimal way, so as to improve economic efficiency. There is a far greater chance of this happening across an area where E.M.U exists. Advice to young people: We can buy things without wrecking our brains trying to calculate what price it is in our currency. Uncertainty caused by Exchange rate fluctuations eliminated. Many firms become wary when investing in other countries because of the uncertainty caused by the fluctuating currencies in the EU. Investment would rise in the EMU area as the currency is universal within the area; therefore the anxiety that was previously apparent is there no more. Single currency in single market makes sense. Trade and everything else should operate more effectively and efficiently with the Euro. Single currency in a single market seems to be the way forward. Rival to the "Big Two". If we look out in the world today we can see strong currencies such as the Japanese Yen and The American $. America and Japan both have strong economies and have millions of inhabitants. A newly found monetary union and a new currency in Europe could be a rival to the "BIG TWO". EMU can be self-supporting and so they could survive without trading with anyone outside the EMU area. The situation that EMU is in is good as it seems that it can survive on its own, with or without the help of Japan and U.S.A.

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Prevent war. The EMU is, and will be a political project. It's founding is a step towards European integration, to prevent war in the union. It's a well known fact that countries who trade effectively together don't wage war on each other and if EMU means more happy trade, then this means, peace throughout Europe and beyond (we hope). Increased Trade and reduced costs to firms. roponents of the move argue that it brings considerable economic trade through the wiping out of exchange rate fluctuations, but as well as this it helps to lower costs to industry because companies will not have to buy foreign exchange for use within the EU. For them, EU represents the completion of the Single European Market. It is vital if Europe is to compete with the other large trading blocs of the Far East and North America. The Political agenda. here is also a political agenda to European bank (the European System of Central Banks -ESCB), the complete removal of national control over monetary policy and the partial removal of control over fiscal policy. Individual nation states will lose sovereignty (i.e. the ability to control their own affairs). It will be a considerble step down the road towards political union. There are many in the EU who faviour economica dn political union and they are very much in facour ot EMU. There are also many who wish to keep national sovereignty and are strugging to prevent EMU, whatever its merits might be, from going ahead. Inflation. From the mid-1980s onwards, there were a number of economists and politicians who argued that, for the UK at least, EMU provided the best way forward to achieve low inflation rates throughout the EU. During the first half of the 1980s high inflation countries, such as France and Italy were forced to adopt policies which reduced their inflation rates to something approximating the German inflation rates to something approximating the German inflation rate. If they had not done this, the franc and the lira would have had to be periodically devalued, negating the fixed exchange rate advantages of the system. Effectively, the German central bank, the Bundesbank, set inflation targets and therefore monetary targets for the rest of the EU. At the time, there was much discussion of why Germany had a better inflation record than many other European countries. The consensus emerged

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that it was because the Bundesbank, the German central bank, was independant of the German Government. In countries such as the UK and France, central banks were controlled by governments. If the UK government decided to loosen monetary policy, for example, by reducing interest rates, it had the power to order the Bank of England to carry out this policy on its behalf. There have always been especially strong pressures before an election for UK governments to loosen the monetary reins and create a boom in the economy, with the subsequent increase in inflation following the election. The Bundesbank, in contrast, was independent of government. By law it has a duty to maintain stable prices. It can resist pressures from the German government to pursue reflation policies if it believes that these will increase inflation within the economy. Events of the early 1990s have shaken the naieve faith that linkage to the independent ESBC, the central bank of Europe would solve all inflationary problems. This is because German inflation rates in the early 1990s rose to over 4% as Germany strugged with the consequences of unification. In 1993, inflation was nearly three times as high in Germany as in the UK and twice as high as that in France. Some countries, such as France, have made their central banks independent on the Germany model and therefore arguably don't need to the EMU link to Germany to maintained low inflation.The UK has gone a little way towards giving more power to the central bank by publishing reports of monthly meetings between the Chancellor of the Exchequer and the Governenor of the Bank of England. This forces the Government to justify its monetary policy publically and makes it harder for it to use interest rates for short term political ends.

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Reference

http://tutor2u.net/economics/revision-notes/a2-macro-monetary-policy.html http://www.ehow.com/info_8492054_monetary-its-effect-macroeconomic-factors.html http://www.investorglossary.com/microeconomics.htm http://www.investorglossary.com/macroeconomics.htm http://economicsconcepts.com/micro_and_macro_analysis.htm

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Coursework
1. Please describe the change in demand. You may use the graph to make your description. A change in one or more of the determinants of demand will change the demand data (the demand schedule) in the table accompanying Figure 3.3 and the therefore the location of the demand curve there. A change in the demand schedule or, graphically, a shift in the demand curve is called a change in demand.

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2. What is command system? Explain carefully? Command system is an economy where supply and price are regulated by the government rather than market forces. Government planners decide which goods and services are produced and how they are distributed. The former Soviet Union was an example of a command economy and also called a centrally planned economy. The command system is also known as socialism or communism. In that system, government owns most property resources and economic decision making occurs through a central economic plan. A central planning board appointed by the government makes nearly all the major decisions concerning the use of resources, the composition and distribution of output, and the organization of production. The government owns most of the business firms, which produce according to government directive. The central planning board determines production goals for each for each enterprise and specifies the amount of resources to be allocated among industries on the basis of the central planning board's long-term priorities. A pure command economy would rely exclusively on a central plan to allocate the government-owned property resources. But, it reality, even the preeminent command economy----the Soviet Union----tolerated some private ownership and incorporated some market before its collapse in 1992. Recent reforms in Russia and most of the eastern European nations have to one degree or another transforms their command economies to capitalistic, market-oriented systems. China's reforms have not gone as far, but there have greatly reduced the reliance on central planning. Although government ownership of resources and capital in China is still extensive, the nation has increasingly relied on free market to organize and coordinate its economy. North Korea and Cuba are the last prominent remaining examples of largely centrally planned economies. Other countries using mainly the command system include Turkmenistan, Laos, Belarus, Libya, Myanmar, and Iran.

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