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Monetary policy of a globalised economy

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PROJECT ASSIGNMENT ECONOMICS-1 MONETARY POLICY OF A GLOBALISED ECONOMY SUBMITTED BY: PRANEETH RAMANAVARAPU I.D.NO 1352 1ST YEAR I TRIMISTER DATE OF SUBMISSION: 6TH SEPTEMBER, 2004 NATIONAL LAW SCHOOL OF INDIA UNIVERSITY Nagarbhavi, Bangalore TABLE OF CONTENTS INTRODUCTION..............................................................3 RESEARCH METHODOLOGY.............................................4 CHAPTER 1......................................................................5 CHAPTER 2......................................................................7 CHAPTER 3......................................................................13 CONCLUSION...................................................................19 BIBLIOGRAPHY................................................................20 INRODUCTION Macroeconomics is the study of behavior of the economy as a whole. It examines the forces that effect large number of firms, consumers, workers at the same time. It contrasts with microeconomics which studies individual prices, quantities and markets. Many economists consider the development of macroeconomics to be one of the major break through of twentieth-century economics. Through the choices of macroeconomic policy a nation can substantially manipulate the direction in which it economy is moving. This essentially means that by employing several instruments of macroeconomics especially those affecting the money supply, taxes, and government spending, a nation can either accelerate or slow down its economic growth. It can also trim the excess of price inflation and unemployment from business cycles or take adequate steps to deal with imbalances that arise in foreign trade or international finance when ever needed. This is considered to be the basic reason why macroeconomic issues have dominated the political and economic agenda of countries around the world for much of the twentieth century The very survival and existence of many nations might depend on the sucesss of their macroeconomic policy. Even ideologies have been shattered by failure of macroeconomic policy. Macroeconomic failures brought down the mighty communist regimes of Soviet Union and Eastern Europe and have convinced people of the economic superiority of private markets as the vest approach to encourage rapid and stable economic growth in the world. Monetary policy is a very important instrument which governments can use to affect macroeconomic activity. Here we intend to study monetary policy in a globalised economy. Globalised economy is essentially an open economy. ...read more.


In addition it must avoid ongoing inflation and deflation by ensuring that the domestic money supply does not grow too quickly or too slowly.16 External Balance The concept of external balance is more difficult to define than internal balance because there are no natural benchmarks like full employment or stable prices to apply to an economy's external transactions. Whether an economy's trade with the outside world poses macroeconomic problems depends on several factors, including the economy's particular circumstances, conditions in the outside world and the institutional arrangements governing its economic relations with foreign countries. A country that is committed to fix its exchange rate against a foreign currency for example may well adopt a different definition of external balance than one whose currency floats.17 Most economists often identify external balance with balance in a country's current account. While this definition is appropriate in some circumstances it is not helpful as an general benchmark. For example a country's opportunities for investing the borrowed resources may be attractive relative to the opportunities for investing the borrowed resources may be attractive relative to the opportunities available in the rest of the world. In this case paying back loans from foreigners poses no problem because a profitable investment will generate a return high enough to cover the interest and principal on those loans. Similarly a current account surplus may pose no problem if domestic savings being invested more profitably abroad than they would at home.18 In more general terms we may think of current accounting imbalances as providing another example of how countries gain from trade. The trade involved is what we have called intertemporal trade that is the trade of consumption over time.19 Just as countries with differing abilities to produce goods at a single point in time gain from concentrating the worlds investment in those economies best able to turn current output into future output. Countries with weak investment opportunities should invest little at home and channel their saving s into more productive investment activity abroad. ...read more.


However there are certain concerns also about this monetary union. Many economists skeptical and point out that the individual countries will lose the use of both monetary policy and exchange rate as tools of macroeconomic adjustment. There has also been a worry that Western Europe is not an optimal currency area because of the rigidity of its wage structures and the low degree of labor mobility among the different countries. Monetary union may therefore condemn unfortunate regions persistent low growth and high unemployment. Nevertheless European monetary union is one of the greatest experiments in the history of monetary policy. CONCLUSION One must conclude saying that the monetary policy of North American and western European countries more or less has been quite successful. However the international monetary system continues to be a source of turmoil, with frequent crises as many countries encounter balance of payments and currency crisis. However the major changes have been taking place in the monetary policies of Europe, America and Japan which conduct independent monetary policy with flexible exchange rates while smaller countries either float or have fixed rates tied to one of the major blocks. One can say that the major test for the next few years will how strong the new European union remains. The operation of monetary policy has new implications in an open economy. An important example involves the operation of monetary policy in a small open economy that has a high degree of capital mobility. Such countries which operate on a fixed exchange rate essentially lose monetary policy as an independent instrument of macroeconomic policy.as its interest rates are aligned with those countries with whom it pegs its interest rates. Therefore one can say that fiscal policy by contrast becomes a powerful instrument because fiscal stimulus is not offset by changes in interst rates It can therefore be said that the monetary policy of many nations will evolve further in the new millennium but in which direction this change will take place depends on the failure or success of the existing policy. ...read more.

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