Macroeconomic in Finance Essay Example | Topics and Well Written Essays - 2000 words

Macroeconomic in Finance - Essay Example These models also highlight the interrelatedness of variables in the economy, which is one of the core concepts in contemporary macroeconomics. Explain how the effectiveness of both fiscal and monetary policy is dependent on the sensitivity of money demand to the interest rate in the closed-economy. Explain how other factors may also impact on policy effectiveness. Monetary policy is "the government or central bank process of managing the money supply to achieve specific goals such as constraining inflation, maintaining an exchange rate, achieving full employment, or economic growth." The monetary policy tools refer to the policy tools of the central bank used to affect the money supply and interest rates such as open market operations, changes in the discount rates, and changes in the reserve requirements (Mishkin 2004). It should be noted that the effectiveness of all these policies rests on the relationship between money supply and interest rate. Accordingly, an increase in the money supply tends to bring a reduction in the interest rate while a decrease in money supply brings about a rise in interest rates. It is notable that without affecting the interest rate, monetary policy renders no effect on the economy. For example, a government wishing to eliminate unemployment pursues an expansionary monetary policy lowering the reserve ratio. Th is in effect will lead to excess reserve rates and encourages bank lending while increasing the money supply. Since interest rate is inversely related with money supply, interest rate falls which encourages investment. Aggregate demand increases and unemployment is reduced or eliminated through the creation of