Economics Paper

EconomicsPaper

Understandingof economic theories is critical in the analysis of different aspectsaffecting the economy. For instance, when the economy is faced withinflation, economic theory can be used in coming up with a policythat can help in curbing the inflation. Monetary policy is one of thepolicies that can be used in influencing the economy, whenever it isnot functioning well. For example, in instances, where the economy isnot growing due to unemployment monetary policy can be used instabilizing the level of employment. In using the monetary policy,the reserve requirement ratio is one of the most importantinstruments that can be used. In this assignment, monetary policy andreserve requirement ratio will be discussed and two articles willalso be related to these two topics.

Ineconomics, reserves describe the part of bank deposits, which bankshold and do not give out these deposits as loans. The reserve ratiois usually expressed in terms of a percentage. This reserve ratio isusually determined by the central bank of any country. Therefore, therequired-reserve ratio describes the portion of deposits, whichregulators require banks to hold in their reserves and not issue asloans. This implies that in case the required reserve ratio is 10% ina given country, banks should hold 10% of the deposits it has inreserves, but can opt to loan out the remaining 90%. The reserveratio is critical because it influences the money supply the levelat which banks add to the money supply is usually directly influencedby the required reserve ratio. In case the required reserve ratio ishigh, less money is likely to be created. On the other hand, in casethe required reserve ratio is low, more money is likely to be createdby a bank. This is an indication that the central bank, which is theregulator of commercial banks, should determine the required reserveratio wisely. Besides, the required reserve ratio is significantbecause it helps in preventing a run on the bank. This is asituation, where depositors lose confidence of a bank in safeguardingtheir deposits and demand all their withdrawals at once. Therefore,the required reserve ratio is significant since it helps banks tohave sufficient reserves that can avoid depositors from losing theirconfidence with the banks’ role of safeguarding their deposits.Sometimes, run on banks can have a ripple effect on the economy incase consumers lose confidence with large banks that are verysupportive to the economy. This shows the immense importance of arequired reserve ratio.

Monetarypolicy describes measures that become employed by the government inorder to influence the economic activity this is usually donethrough the manipulation of the money supply and credit or throughaltering the interest rates. Lowering the level of interest rateshave an effect of encouraging investment and spending this resultsto an increase in aggregate demand and subsequently to economicgrowth. The diagram below shows the effect of low interest rates onan economy

Lowinterest rates would result to an increase in real GDP from Y1 to Y2as indicated above. On the other hand, high interest rate will havean effect of lowering the real GDP as indicated in the followingdiagram

RealGDP

Thecommon goals of using the monetary policy are to maintain or attainfull employment, to maintain or attain a higher economic growth rate,and to stabilize wages and prices. Monetary policy is critical sinceit can be applied in instances of inflation for example, crude oilprices may result in inflation, but this policy can be used inensuring that the inflation as a result of crude oil price isstabilized. The regulatory authorities can use three chiefinstruments of monetary policy in regulating money supply theseinclude discount rates, reserve requirements, and open marketoperations.

Thenews article, Chinesebanks push for reduction in reserve-requirement ratio,relates to the required reserve ratio topic. The article relates tothis topic because it presents the idea that Chinese banks lookforward to have the Chinese central bank lower the required reserveratio in order to enable the banks to make more money. According tothe news article, the reserve requirement ratio set by the Chinesecentral bank is 20%, but the banks want this ratio decreased. Thearticle indicates that reducing the reserve requirement ration by0.5% would help in boosting the banks’ liquidity by approximately500 billion Yens. Besides, the article relates to the reserverequired ratio since it shows how banks can benefit from a lowreserve required ratio. A low reserve required ratio encourages banksto increase money supply, which is the case presented by the article.The news article further relates to the reserve required ratio topicsince it shows the effect of decreasing the ratio on the economy.According to the article, Chinese officials are of the idea that incase the reserve ratio is lowered, banks will tend to prioritizelending to the state-owned organizations and exclude small,privately-owned entities from lending as a way of reducing risk. Thiswould undermine the aim of the government of propping up the slowingeconomy through encouraging better weighted growth different businesssectors. Furthermore, this article is related to the monetary policysince it discusses the application of reserve ratio in influencingthe economy reserve ratio is an instrument of monetary policy.

Thenews article, monetarypolicies, crude oil prices at work in yen’s fall,is related to the topic of monetary policy. The article presents theidea of the government using interest rates in influencing theeconomy. This idea of using the interest rates in influencing theperformance of the economy is related to the monetary policy.According to this article, the depreciation of the Yen is promptingthe use of the monetary policy because the depreciation is as aresult of differing monetary policies amid the United States andJapan. The U.S. Federal Reserve Board has decided to end quantitativeeasing policy and considering a hike in interest rates. On the otherhand, the Bank of Japan is considering easing its monetary policyfurther. These two actions presented in this article is an indicationof the action of the monetary policy. The article is also related tothe topic of monetary policy since it shows how monetary policy canaffect a currency. According to the article, the monetary policy usedby Japan has led to the devaluation of the Yen. However, through theeasing of its monetary policy, Japan is looking forward to strengthenits currency.

Economictheory is critical in providing an insight to analyzing the newstopics presented. Through applying the economic theory, it ispossible to understand and discuss the contents of the news articles.The economic theory presented in the news articles is the quantitytheory of money. According to this theory, an increase in thequantity of money in the economy would subsequently result in a riseof price level of services and products. In the short run, anincrease in the money supply will cause a decrease in the demand ofmoney, a move that may end up causing a devaluation of the money inthe long run. It is this devaluation that makes money less attractivein purchasing commodities and services, which pushes the price ofcommodities and services up since the money can only purchase fewgoods. Besides, price level may increase due to an increase in theinterest rates that emanate from an increase in money supply. Thefollowing diagram shows the effect of an increase in the money supplyin the economy in the diagram, an increase in the money supply leadsto an increase in the aggregate demand, which pushes the price levelup.

PriceLevel LAS

SAS2 SAS1

P2

P1

AD2

AD1

RealGDP

Accordingto this theory, money supply is usually determined by the level ofdeposits maintained by banks in their reserves. The amount held inthe bank reserves is determined by the reserve requirement ratio,which is an instrument of the monetary policy. The news articles havediscussed the issue of monetary policy, which can be discussed wellthrough understanding the quantity theory of money. Therefore,through understanding the quantity theory of money, it was easy todiscuss the news articles presenting the monetary policy.