2. Interest rates, the price level, and employment are closely interrelated conc

Question

2. Interest rates, the price level, and employment are closely interrelated concepts in macroeconomics.

A. Describe the cause of stagflation and explain why stagflation presents difficulties for economic policymakers. (10 points)

B. Describe the factors that lead to higher and lower interest rates, and explain how these changes in interest rates affect the economy. (9 points)

C. Describe the crowding-out effect, and explain how this effect impacts a nation's economy. (9 points)

D. Countries often impose trade barriers against other countries. Explain how trade barriers affect both the domestic economy of the country imposing them and the global economy as a whole. (10 points)

Explanation / Answer

2. A. Stagflation is often caused by a supply shock. It is an unusual situation. Monetary policies of a nation can also result in stagflation. For example, pushing too much money into circulation coupled with fiscal policies like over taxing or over regulation could bring stagflation. Stagflation presents a policy dilemma because most actions to assist with combating inflation worsen stagnation and vice versa. Both inflation and stagflation can result from inappropriate macroeconomic policies.

2. B. Inflation is one of the factors affecting interest rates. The higher the inflation rate, the more interest rates are likely to rise. Because, lenders will demand higher interest rates as compensation for the decrease in the purchasing power of the money they will be repaid in the future. Lower the interest rate, lower the expected interest rate to prevail.

Government can also influence the fluctuations in the interest rates. By the federal funds rate affects the interest rate when Fed performs open market transactions. When the federal government buys more securities, the interest rate decreases, and when it sells in the open market, interest rates tend to rise.

2. C. The “crowding out effect” is a general term often used in reference to the stifling of private spending in areas where government purchasing is high. In simple terms, rises in public sector spending drives down or even eliminate private sector. Crowding out effect slows down business activity, there is a reduced access to credit because of high government spending, and also reduces GDP growth rate because of government funds are used for non-productive purposes.

2. D. Tariffs increase prices of imports, discourage their demand, and insulate domestic producers to a certain degree from foreign competition. As a result, each country places higher tariff on goods determined to be import-sensitive. It is a worrying trend, as countries follow protectionist policies, rush to shield their ailing domestic industries during a global economic crisis. Protectionist measures may also sharply worsen the collapse of the global trade.

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