Research Paper on Money and Banking Essay Example Essay Example

Research Paper on Money and Banking Essay Example Paper Money and Banking Research Paper G. Bush indeed seems to have resurrected some major basic principles of reaganomics in his tenure as president of the USA. The current fiscal policy of the Bush administration can be called expansionary due to the great tax cuts and increases in defense spending. The Federal reserve on the other hand uses restrictive monetary policy in order to offset the effects of the current government increases in spending on the US economy. In order to better understand the impact of the increased government spending on the GDP, one should understand the economic framework as represented by the GDP formula. Y=C+I+G+T+NX or Y=C+S+TWhere Y = real output (GDP), C = real consumption expenditure, I = real investment expenditure, G = real government expenditure, NX = real net exports, S = real saving, T = real (net) taxes = taxes -transfer payments From rearranging the terms in the formula noted above one can obtain the following: Research on Money and Banking Essay Body Paragraphs NX = (S-I) + (T-G) which relates directly the net exports (exports minus imports) to the real savings less investments and taxes less government spending. During the presidency of George Bush, expansionary monetary policy would mean that the government had drastically increased government spending on the military and other public works as initiated by Bush (Dam, 61). The second major contributor to the increased aggregate demand and financial resources available on the market was the tax cuts which increased real consumption expenditure. The increased consumption and amount of money on the market which appears as a result of such government spending had the following impact on the economy: Increased inflation, CPI Increased GDP The Fed’s contractuary policy which means establishment of bank’s reserve requirements, interest rates and other measures influences the US economy in the following manner: Increased Interest rates. Attract money from abroad for reinvestment to t he USA Control over the exchange rates. During the First Bush’s term as a president the USA had witnessed some major spending in the country, which certainly surpassed savings and attracted foreign credit from abroad. In simpler terms that meant that foreigners are selling goods to the USA in exchange of US dollars and then pour these dollars back into the USA to allow Americans purchase these goods on credit since Americans currently spend more than they earn, so they need some credit. Due to the increased spending, the prices of goods and services increase as seen during the first presidential term of G. Bush. The presence of extra cash on the market pushes the interest rates down and the historically low interest rates in the USA just a few years ago show us that. At the same time as the average American borrows more from abroad as foreigners invest the funds earned in the USA back in the USA the USA becomes more and more leveraged and risky, so the interest rates ultimate ly will have a tendency to increase. Or by the same token the prices of goods and services will tend to increase if these companies want to incorporate the risks in the goods rater than in the interest rates directly (Heintz, 142). The USA dollar had seen a decline as it would be viewed as becoming riskier than before due to the great leverage of American credit system. The Fed would increase the interest rates slightly to establish an elbow room for manipulation and better control of the monetary policy. Unless, there is no change to the existing fiscal and monetary policy to make them both somewhat more conservative/contractuary/restrictive to reduce not only the government spending yet rather the borrowings made Americans. While some borrowings might be good as Americans are able to increase the GDP due to the increased spending as well as enjoy low interest rates and easy access to capital, excessive borrowings make the country and the economy risky and unstable which would caus e investors demand higher interest rates for the funds. If the situation continues as it is at present into the next several years, one would expect the interest rates in the USA increase further, just like the CPI and the national debt making the US dollar shaky and weaker than the Euro. How will the Bernanke’s â€Å"savings glut† concept fit into demographic changes around the globe? In order to provide a sufficient answer to this question, one should use a common sense explanation for the concept of ‘savings glut’ which certainly relates to the current financing by the central banks in Asia of the US current account deficit. While everyone knows that saving is good, the common tendency in the USA is to spend more than one can save. The problem is that in the modern global economy the rest of the world as represented by Europe, Asia and Latin America is saving too much while spending too little. This phenomenon is what one calls the â€Å"global savings glut† The savings glut phenomenon as presented by Bernanke allows one to understand US trade deficits, the weaknesses of the US economic system and the difficulty (existing problems) in doing something with the deficit and the weaknesses. One learns in school that savings is good since it allows one to afford expensive items such as home, car or a university tuition as well as establishes a safety margin which would protect an individual against unexpected emergency expenditure or retirement. For the overall society savings represents an ability to invest in new companies, factories, technologies, plants and businesses. The savings as we know them remain in the border of the country, i.e. Americans save their money in America, while the Japanese save in Japan. These savings thus balance with the interest rates and stock prices. So if people save more than businesses want to invest the interest rates will fall and in turn encourage investment and reduce savings in the country. In practice the real world situation is different. In the 1970s and 1980s when the Breton Woods system was deemed outdated and the capital controls restricted the citizens from moving capital into foreign stocks and other financial paper. Nowadays, banks, insurance companies, investment and mutual funds, let alone individual governments engage in moving capital abroad in search of opportunities. The figures are rather high with major European powers having invested several trillion dollars abroad. For instance in 2003, Germany had over $4 trillion invested in savings abroad, while France had $3.2 trillion kept in foreign savings. The modern day savings do not remain attached to one country with Japanese saving over 24% of their income and keeping 75% of these savings in foreign countries. Most Asian countries like China, Japan, Korea or Indonesia are high savers with the majority of the money going to the USA. The current situation when the majority of goods flows into the USA, mea ns that Americans can spend more and save less. In the 1990s the excessive savings especially those coming from abroad went directly into the stock market fueling it for several years. Since the stock market grew, Americans felt as getting wealthier and thus felt like saving less and spending more on goods and services which in turn would further improve the corporate performance and the stock market which increased the portfolios of these Americans (Dam, 64). The foreign money especially those from the foreign banks would go to the US debt and equity market keeping the interest rates low. The low interest rates would mean affordable mortgages. The increased demand for housing would increase the prices of houses and make Americans wealthier since the value of their hoses increases. This in turn would allow them to save less and consume more (French, 287). Currently, the US increased consumption and low savings rates surpass the foreign high savings and low consumption rates. The cur rent US trade deficit relies heavily on imports, while foreign relatively small spending on the US goods hurt the US producers/exports. The desire of foreigners to keep the money in the US banks increases demand for the US dollar on the forex market and by increasing its value reduces competitiveness of the US goods. The European Union, Japan and Canada buy over 47% of the US exports. Up till present the current system looks like a huge recycling plant where everyone benefits. The USA gets cheap foreign goods which allow Americans to keep inflation at a minimum level. Foreign countries improve their economies as increased production can easily sell on the US market. Still, this system cannot continue indefinitely and it might negatively impact all players. Foreigners might choose not to invest in the USA which gets riskier and riskier, thus putting a downward pressure on the US dollar. Dollar might fall against some currencies. Still if these countries with increased savings did not invest at home, the global economic growth would be halted or the US recovery would also be tempered. The trade deficit means that US employment might suffer as foreign imports would move production abroad. Finally, I would like to note that the US huge trade deficit and the foreign countries’ huge savings pose global danger since the USA cannot control anything. The fact that foreign countries save in the USA means that there are at present no domestic savings opportunities or no developed consumption. The Asian countries which currently power the USA the greatest prefer export-oriented economies and reduced local consumption. The volatile economy of Latin America deter investments, while Europe’s heavy taxation and numerous regulations also make the USA the only investment opportunity for foreigners. The only way for Americans to survive this situation is to remain the best investment opportunity in the world, since the rest is not controlled by the USA. 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