Analysis of Economic Growth essay

Analysis of Economic Growth

Economic growth is the increase in aggregate output between two distinct periods of time (Romer). Leading to a general improvement in the standard of living, the economic growth of a nation is typically believed to be caused by several growth factors working in tandem. These growth factors may include the growing literacy rate among a population, the opening of the trading environment, the beginning of a market economy, the opening of international markets, and the efficient use of natural and human resources (Pritchett).

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Even though economic growth is desirable, it may be accompanied by inflation, seeing as economic growth entails increased spending. This happens when people, groups, businesses, government, and foreigners demand or try to spend more than the economy could produce at full employment. Prices will be bid up in this case, and until the excess demand for goods and services is reduced or the capacity of the economy to produce is expanded, price levels would continue to rise (Wilson).

Indeed, inflation acts as a disease affecting all parts of the economy at the same time. It leads to a redistribution of wealth and income among different groups, and also a distortion in the relative prices and outputs of different goods, plus the output and employment for the economy as a whole (Samuelson and Nordhaus). Retired folks and those living on fixed income experience that their standards of living must be reduced with the advent of inflation (Gerolamo). However, those who owed money to entities that allowed them fixed interest rates, find that they now have to pay back less in value than before. An individual who borrowed $100,000 to buy a house with annual fixed interest rate mortgage payments of $10,000 – has to keep on paying the same amount in mortgage payments, even though inflation reduces the value of money. Here, the creditor is the one at a loss, as inflation strikes the economy as a whole (Samuelson and Nordhaus). Commercial banks that experience a decrease in value of bank loans do also see a loss in the value of depositors’ savings (Gerolamo).

Moreover, inflation makes it difficult for businesses to plan for the future. During inflation, it is not easy for a company to decide how much to produce, since it cannot predict the demand for its goods at higher prices. High inflation does not only disrupt the operation of a nation’s financial institutions and markets, but it also discourages their integration with the world’s markets. By producing uncertainty about future prices, interest rates, and exchange rates, inflation increases the risk among potential trade partners, thereby discouraging foreign trade (Gerolamo).

As government, investment, and consumer expenditures have an expansionary effect on the economy, the demand of money may increase in a boom or a period of high economic growth. The shortage of money would force up interest rates to boot, as it would become more expensive to borrow desired sums of money. Private spending that is interest-sensitive would decrease due to high rates of interest. Hence, the aggregate expenditures causing the boom may also be reduced although these expenditures are sought by the economy with reference to growth and higher levels of production that these expenditures beget (Lipsey and Harbury). What is more, as mentioned previously, high levels of expenditure translate into high demand for products and services across the economy. High demand must be met by high supply of products and services in high demand, otherwise inflation is a definite result, seeing that prices could be raised due to high demand that is not met by an equal level of supply. The government may plan on raising interest rates, or reducing money supply to deal with this problem.

Stabilizing the money supply stabilizes the economy. In this case, the free-market interest takes over to vary pro-cyclically. It dampens down booms and mitigates the slumps. To bring the economy out of recession, that is, a period of economic retardation, the Federal Reserve could either vary the money supply or interest rates. By lowering interest rates — a better option — the economy would make it appealing for investors to engage in business in order to bring the economy up to a level of growth. On the other hand, if the money supply is changed, the Federal Reserve may decide to increase the supply of money; this option involves a lot of other variables, however, and must be used with great care. If the money supply rises above some target set to bring the economy up from a slump, again the interest rates would have to be altered to get required results (Lipsey and Harbury).

In a situation where unemployment is lower than anticipated unemployment and there is an upward pressure on wages, to prevent inflation the Federal Reserve may decide to control the money supply by reducing it. The interest rates would increase with the shortage of money, as discussed before. It would cost more to invest, thus decreasing the chances of inflation through too much money being c…………………………