Stagflation paper

Stagflation paper

Stagflation is an economic situation where there is high unemployment, stagnant demand being experienced, and the low rate in the production of goods and services. It can also be termed as a situation where there is a high rate of both stagnation and inflation rate in the economy. Macleod (2007), outlines that one of the significant causes of stagflation to the economy of any country might be if the economic policies that are being passed in a country affect the industries negatively, in that, it makes the production of goods and services to be expensive while at the same time increasing money supply in the economy too quickly. This leads to a resultant high rate of inflation in the marketplace and a rise in the cost of living. [unique_solution]

Stagflation can also be caused by a supply shock. In that, if the price of essential products such as oil, is brought to the market becomes excessively high, it leads to overall rise in prices of other products in the market and at the same time causes a lag in the economic growth of the affected country because the cost of production becomes excessively high and the profits being enjoyed are less. Nitzan (2015) explains that stagflation is considered the worst possible macroeconomic problem because all the macroeconomic objectives of full employment, stability, and economic growth are no longer achievable, and it is tough to correct the situation.

Answer to question 2:

Expansionary fiscal policy in the basic Keynesian model is used to stimulate aggregate demand and to enable the economy to recover from a recession. It can be done by reducing the current tax rates in the country, which encourages the consumption among households and investments in the country. Kollewe (2011) stated that an increase in the spending of the government at that particular period also helps to shift the aggregate demand curves of the citizens to the right and, as a result increasing the demand of the consumers for goods and services offered.

Based on the Philips curve, when the economy is on a recession and the gross domestic product is lower than it should be and unemployment levels are also high, inflationary pressures would be more economical, and the economy will have lower inflation, once expansionary fiscal policies of reducing taxes and increasing government expenditure are implemented, it leads to a resultant change in the employment levels in the country and more people will become employed because the aggregate increase in demand leads to an increase in the output and will compel firms to hire workers and increase their nominal wages. Phillip (1957) states that more employment leads to an increase in spending since people have more disposable income, demand-pull inflation then occurs, which means that the prices of goods and services increase. The rise in inflation, therefore, means that the overall unemployment levels will be lower, and the economy can operate at full employment, and the macroeconomics goals are achieved in that case.

Answer to question 3:

Most democracies during the 1970s including Canada and the United States opted to enjoy short term gains of using expansionary fiscal policies such as increased output in the economy that is brought about by the increase in aggregate demand because the economy would become stable in the short run and as a result, they would be able to tackle the immediate economic situation at hand and would then be able to implement and put better strategies that would enable them to handle the harsh economic times that would be ahead of them and imminent in the future.

They also wanted to gain from the multiplier effect in the short run. Charles (2015) states that this effect comes about because an increase in government spending or when the government spends any additional dollar, a citizen will receive it. The citizen may then decide to save part of it and spend the rest, depending on the amount of disposable income that they have. This cycle continues, creating a multiplier effect because the other person receiving the money that the earlier person had spent would also decide to save part of it and use the rest for other purposes. This, therefore, would ensure that the economy would be favorable to the citizens in the short run, and as a result, the citizens could enjoy these benefits. The citizens could understand the impending uncertainties in the future because their earlier benefits in the short run could have overshadowed the pain that they could get in the future.

Expansionary fiscal policies ensured increased employment in the short run. This would make the citizens to be contented and to have the notion that the government was addressing their issues and was conscious of them. This would then favor their political stands in the society since they would gain favor in the eyes of the electorate.

Answer to question 4:

Monetarists allude that inflation is always a monetary inflation phenomenon because they argued that if the money supply rises at a rate that is faster than the growth of the gross domestic product of a country or the national income, then there would be inflation. They argued that a decrease in money supply or an increase in money supply in the economy are the essential factors that could contribute to low rise or high inflation, respectively. Friedman (1999) stated that rise is always a monetary phenomenon because it can only be produced by an increased quantity of money than in output.

An economy can suffer from inflation even if the money supply is not increased. This, however, is dependent on the meaning of inflation that is being referred to and also the money supply aspect. There will be a general increase in the level of prices of goods in a situation where the amount of products and services that are available in the market becomes lesser as a result of factors such as an increase in the production cost or growth in the price of raw materials leading to lower output. This leads to the emergence of a situation where the is more money chasing few goods, and this situation can be termed as inflation.

Inflation can also occur even if the money supply is not increased in case demand curves of the consumers’ shift and become lesser. This will mean that the same initial amount of money will be used to purchase a smaller amount of commodities at prices that are higher than initially, a situation that can be termed as inflation. The prices of commodities will be higher because the business entities will have to raise the rates, since the demand for their products has lessened even though the money supply is still constant to ensure that they do not incur any losses.

Answers to question 5:

An easy money policy is a monetary policy that refers to a situation where money supply increases in the economy as a result of lower interest rates. Interest rates decrease in the short run because the central bank of the country may decide to lower the rate of interest paid by the other commercial banks who usually borrow money from it. This leads to a corresponding decrease in the overall interest rates in the market, and investors can borrow more because they will pay lesser interest rates for borrowing, or it is less expensive to borrow funds. This, therefore, leads to increased investments and increased domestic consumption because their demand for goods will generally increase.

The interest rates can, however, increase in the long run owing to the liquidity effect. Friedman (1999), outlined that the increased money supply also increases the opportunity cost of holding stocks and cash and will be followed by a temporary fall in the nominal rates of interest, that is, the interest rate before inflation is taken into account becomes lower. People are then motivated to convert their cash into other forms that may benefit them such as buying securities, and this leads to reduced money in circulation, this coupled with tight monetary policies that may be implemented ensure that money is taken out of the economy through raising the required reserve requirements of banks and selling of treasury bonds. This leads to a rise in the real interest rates because the demand for credit becomes more, and therefore, the lenders price their loans higher to take advantage and earn a lot from the aggregate increase in demand for loans.