Reference no: EM131523689

As previously discussed, interest rates are critical to the adequate balance of money supply and money demand in the economy. Interest rate is a price and a return.

For borrowers, interest rate is the price of money they buy (demand). During periods of economic decline (recessions), the only way to left the economy is through increasing aggregate demand, which will cause aggregate supply to increase, which will cause unemployment to return to its natural rate (low level of unemployment). This could be achieved through decreasing the price of money (lower interest rate) to stimulate borrowing for consumption and investment. Reducing interest rates is a viable solution as long as the economy bounces back quickly. But what happens if it takes the economy longer time to recover than anticipated where interest rates have to be kept low? From financial investors' point of view, interest rates are the "return to investment". But what would happen if investors are looking for a long-term investment and the economy is not providing them with financial investment opportunities with adequate return?

In general, as long as the economy is not at its potential GDP (potential GDP also refers to full employment), we want people to have easier access to money (lower interest rates) to consume and invest in new businesses. However, we also don't want to forget the other half of the equation, those who supply the market with money. After all, the government cannot borrow indefinitely to increase money supply in the economy.

Given the state of our economy these days (GDP, unemployment, and price level), do you think the Fed should raise interest rates to stimulate the long-term investment by financial institutions or rich people? Or do you think the Fed must keep interest rates at the low level they are at right now until the economy recovers? Justify your answer by elaborating on the effects of high (low) interest rates on borrowing, investment in new businesses, and financial investments?

Also, what would happen to the money supply in the US if a foreign country offers higher interest rate?