Original topic in Advanced MAcroeconomics Essay

Original topic in Advanced MAcroeconomics - Essay Example The balance of payments is usually in deficit. (Adams, 2002, pp. 53-55) A country’s fiscal policy is the mix of government expenditure and revenue collection mechanism in an economy. Historically, governments collect revenues from taxes and their expenditures include public sector expenditures. (Auerbach, 1997, p. 88) A country’s monetary policy is a combination of activities by the state bank or central bank, the government and other financial institutions to control the demand and supply of money and interest rates in an economy. In a nutshell, the effect of each is dependent on the other and that is what the monetary policy aims to control. (Walsh, 2003, pp. 9-12) This case focuses on primarily on monetary policy. To gain a better understanding of how a monetary policy works, we first need to understand its two components i.e. money supply and interest rates. Money supply is generally divided into M1 and M2. Further classifications may also exist. The divisions are based on liquidity of the funds. M1 funds are the most liquid funds and include cash, very short term securities or securities equivalent to cash. M2 funds include those funds which are slightly less liquid than cash like current account deposits. As the liquidity decreases, the number after M increases. In my opinion interest rate is basically the cost of money. It is also the cost of borrowing or the return on investment. Interest rates have two components. The discount rate which is set by the central bank and is the rate at which the central bank lends to commercial banks. The other component is the market interest rate. I believe it differs because of bank’s spreads and their portfolio of customers. In my opinion, the developed nations have always moved towards a relaxed monetary policy as they promote free trade and trade liberalization. In addition the existing well defined systems in these economies allowed for and