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Monetary policy, budgetary policy and stagflation



Kirjoittanut: Nicolas Mamassis - tiimistä Exchange.

Esseen tyyppi: Akateeminen essee / 3 esseepistettä.
Esseen arvioitu lukuaika on 5 minuuttia.

Introduction

Over the past few months, as I’ve watched the news, I’ve come across a word that has questioned me. This word was the stagflation. As I didn’t understand it, I did some researches on it and came to this definition. “Stagflation is the situation of an economy that suffers simultaneously from low or zero economic growth and high inflation.” (Wikipédia, 2022)

This definition allows us to understand that the word “stagflation” comes from the mix of words “stagnation” and “inflation”.

The stagnation refers directly to the fact that there is no, or a very low economic growth.

The inflation is the loss of the purchasing power of a money. It usually leads to an increase of the general prices. (Wikipédia, 2022)

 

What is the USD [1] ?

 

The USD is the official money used in the USA. Between 1944 and 1971, its value was linked to the gold held by the government. It became a fiat money, which means that it is not anymore linked to any external resource such as gold or silver. Its value is now defined by the government and how much they decide to print. The FED is the organism that is responsible of controlling the quantity of USD produced depending on the total amount in circulation. In this essay we will see what are the impacts of the monetary policy that is chosen by a country and how it affects the economy.

The impact of

Producing too much money

By producing too much money, the FED would reduce the purchasing power of the citizens. With the same amount of USD, they would be able to buy less things that they could before. This effect is called inflation. A little inflation rate (0% to 2% /year) is symptomatic of a good economy. But the higher it gets, the more dangerous it goes. Inflation makes that the money that you have value less every day. It will make you want to spend your money quickly because of this. The impact of this is that you will make the economy running, because you will give work to people by buying things. By buying more things you will increase the demand of the primary products that are needed to create the products you bought because of the inflation, and by increasing the demand, price will also increase. If prices also increase, it means that inflation is still growing.

 

Producing too little money

 

By producing too little money, the money that you have would allow you to buy more things than in the past. The purchasing power would increase through time. This effect is called deflation. During a deflation period, people tend to save money, to bigger the value of it. It is good for them, but not for the economy, because they will consume less than in an inflation period, and the economic growth will not be as big as it could. It would also affect people employment rate, because if people consume less, the country has to produce less, and if they do so, they will not need the same number of workers. That is why the FED prefer to keep a low inflation rate instead of deflation.

Stagflation

 

Stagflation is a term that has been used a lot over the past few months. It is the contraction of inflation and stagnation, referring to the economic stagnation. This situation is risky because it is very hard to fight against inflation without reducing the economic growth. By reducing the economic growth, the employment rate will decrease, and if it decreases it will mean the the purchase power will also decrease, inducing reduction of the economic growth again. As you can see, there is a chain reaction of negative outputs.

What is done?

 

Actually, the countries have increased their interests’ rates, and those are still increasing. But why so? By choosing this monetary policy, central banks try to control the rapid inflation. There are 3 main consequences of the interests’ rates increase.

The first one is that it costs more to borrow, and if it costs more to borrow, your power of purchase will decrease. Also, companies will invest less than before because of the high interest rates.

The second effect is that it encourages people to save money. It gets worth to have money in the bank. If people spend less, there is less money circulating and then less inflationist pressure on the economy.

The third effect affects the economic growth. If people spend less and companies invest less, the economic growth will slow down.

The combination of those three effects should help to reduce the inflation but will also reduce the economic growth. The actual challenge is to reduce the inflation to 2-3% while not slowing down too much the economic growth.

(Barria C., 2022)

By changing the budgetary policy, countries also can have an influence on the economic activity. As seen during the COVID-19 pandemic, countries have used a lot of money to help businesses facing the crisis. By increasing the money spent on helping businesses, it should help the economy to recover and stimulate the economic growth. However, this strategy has the risk to increase the inflation rate. The challenge is to manage the monetary policy and the budgetary policy in a way to get out of the stagflationist period and go back to a normal growth with a low inflation rate such as 2-3%.

 

Hypothesis four your money

Regarding Warren Buffet, the best option during an inflationist period is to invest in yourself. Be the best in what you do, no matter what it is. If you are the best at what you are doing, you will be able to get more money out of your job. People will need you more than others, and you will increase your chances to be at the best place for you as it is possible.

During uncertain times, risky investments can also be a good option because everything becomes less predictable.

[1] United States dollar, also abbreviated USD or US

References

Barria, C. (2022, May 9). Inflation : comment la hausse des taux d’intérêt dans le monde vous affecte (et qui en profite). Retrieved from BBC: https://www.bbc.com/afrique/monde-61370710

Klebnikov, S. (2022, March 15). Most Wall Street Experts Now Predict Stagflation—Here’s What That Means For Investors And The U.S. Economy. Retrieved from Forbes: https://www.forbes.com/sites/sergeiklebnikov/2022/03/15/most-wall-street-experts-now-predict-stagflation-heres-what-that-means-for-investors-and-the-us-economy/

Levinson, D. (n.d.). What gives a dollar bill its value? Retrieved from TEDEd: https://ed.ted.com/lessons/what-gives-a-dollar-bill-its-value-doug-levinson

Smith, J. (n.d.). How do governments create money out of thin air? Retrieved from TEDEd: https://ed.ted.com/lessons/how-do-governments-create-money-out-of-thin-air-jonathan-smith?lesson_collection=government-declassified

The Conversation. (2022, March 10). Why stagflation is an economic nightmare – and could become a real headache for Biden and the Fed if it emerges in the US. Retrieved from The Conversation: https://theconversation.com/why-stagflation-is-an-economic-nightmare-and-could-become-a-real-headache-for-biden-and-the-fed-if-it-emerges-in-the-us-179036

The Conversation. (2022, March 16). Why the Fed can’t stop prices from going up anytime soon – but may have more luck over the long term. Retrieved from The Conversation: https://theconversation.com/why-the-fed-cant-stop-prices-from-going-up-anytime-soon-but-may-have-more-luck-over-the-long-term-179339

Vega, N. (2022, May 2). When inflation is high, Warren Buffett says the best thing you can do is ‘be exceptionally good at something’. Retrieved from CNBC: https://www.cnbc.com/2022/05/02/this-is-warren-buffetts-simple-advice-for-periods-of-high-inflation.html

Wikipédia. (2022, January 29). Inflation. Retrieved from Wikipédia: https://fr.wikipedia.org/wiki/Inflation

Wikipédia. (2022, February 17). Stagflation. Retrieved from Wikipédia: https://fr.wikipedia.org/wiki/Stagflation

 

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