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Example research essay topic: Real Interest Rates Factors That Affect - 1,753 words

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Our aim of this part of the project is to go through a detailed analysis of Brazils statistical information which is to be found in the appendix provided. By analysing the data in our appendix we found out the relation between different variables, whether these relations being negative or positive. We must now find out whether those relationships that we have come to conclude actually are consistent with any of the economic theories that we have learned during this course. Our interpretation will be based on the following theories, and these are the Monetarist, Classical, New Classical, Keynesian and New Keynesian. However, it must be noted that we will not mention each and every correlation coefficient that we have obtained in the previous section, but rather only those which are of relevance and provide critical information needed in our report. We would further like to note that the interpretation to follow and the data we have calculated are based on the data we have collected from the IFS.

it is important to note that the following remarks about the above mentioned theories are only our opinions regarding this matter, however, it does not aim to prove the deficiency of these theories. By looking at our statistical data we concluded that the two variables percentage change in Money and percentage change in Output do not move together. This applies for both lagged and contemporaneous percentage changes in money growth. The Monetarists explanation represented in the Equation of Exchange doesnt go with the previous idea. According to the Equation of Exchange MV = PY, which relates nominal income to the quantity of money and velocity. Where (V) is relatively stable and slow to change due to limited improvements in technology and (P) is relatively stable as well in the short run.

Both are not flexible in the short run. Therefore, for the equation to be true, an increase in (M) must be met with a proportional increase in (Y). In addition, what we have observed is not backed up by the Equation of Exchange because our data showed that both these two variables are not related to one another. However, the Classical view in a way go with our data.

The Classical view believes that prices are flexible and so any increase in nominal money supply is met by an equivalent increase in the price level. Thus, the real supply does not change, which would result in keeping the output unchanged. This means that nominal increase in money supply have no effect on output. Not all economist intellectuals share same view. The Keynesian's believe that prices are sticky and therefore when the nominal money supply increases, the proportional increase in prices doesnt occur immediately but would take some time. Therefore, real money supply increases causing an increase in the output of the economy in the short run, prices adjust in the long run however restoring the economy's equilibrium.

So, our data doesnt go with the Keynesian view. The so called policy ineffectiveness proposition is the concept that New Classicals believe in and it implies that changes in the aggregate demand anticipated by the public do not cause any changes in output. On the contrary, only unanticipated changes in Aggregate Demand produce output fluctuations. If we look again at the data we have obtained we will find that it partially consist with the New Classicals in terms of the anticipated changes. For when the public expect the change, they start to accommodate their lives to this change, adjusting the short run aggregate supply curve according to that. This was proven in our case of Brazil where we found that lagged increases in money supply had no effect on output.

This is not absolutely true because although New Classicals anticipated policy has no effect on output, it does have an effect on the overall performance of the economy, something which our data is not sufficient to address. Unlike the New Classical model, anticipated policy does have an effect on aggregate output in the New Keynesian model. For them, anticipated changes cause (AS) curve to shift but not as much as the (AD) curve in order to restore equilibrium to (Yn), that because of rigidities do not allow complete wages and price adjustments which moves the economy to a point where output is higher than its original level. Therefore, New Keynesian's believe that anticipated changes have an effect on output unlike percentage changes in lagged money growth from our data which implies no relation.

This also does not match our data for contemporaneous increase in money, which proved no relation between money and output. Because That is because New Keynesian's believe that unanticipated changes also have a effect on output because in this case the (AS) remains in the same position and the (AD) curve increases shifting to the right. So the economy moves to a point where the output is higher than the natural level. Our observations also show that percentage change in Money and Real interest rates positively move together.

If one variable of the two increases, the other will increase also. Keynesian's believed that there are other factors that affect the real interest rates other than money supply. They claimed that money is sensitive to interest rates and that it is inversely related to it. He explained by referring to the speculative motive of money demand. If people believe interest rates will rise, they tend to hold money not bonds and vice-versa... The higher the interest rate, the more people there are who believe that interest rates will fall, and hence the lower is money demand and vice versa.

This means that interest rates determine how much an individual is likely to hold. Having said this, it is quite clear that our data reflect the opposite of Keynes argument as it shows a positive relationship rather than a negative one. There are no theories suggesting that real interest rates and money move together as far as we know, however there are a few that believe they are not related like the Classicals and Monetarists. Similar to money and output, our data shows a positive relationship again between percentage change in Money and percentage change in Price level.

Fortunately, unlike the latter, this does adhere with a few theories that we have discussed, and these are both the New Classicals and New Keynesian. They do agree that changes in the real interest rate as a result of changes in the money supply cause the (AD) curve to shift higher (to the right), which inevitably leads to price level increasing. However, both theories do differ in a very critical matter and thats is the time that it actually takes for those changes to occur. This is of special interest to us as we are studying the effects of both contemporaneous and lagged variables. In the case of the New Classicals, prices are flexible, (AD) increase due to anticipated expansionary policy. (AS) also shifts (to the left) because the policy is expected, moving the economy to a new equilibrium where output is the same as its original level but the price level has increased.

In the case of unanticipated policy peoples expectations fall short of the reality, they expect (AD) to shift more than it really does and adjust the (AS) curve accordingly. The economy ends up at a point where the output is less than the original level and with a price level that is lower than that of the anticipated policy. We conclude by this that the New Classicals show a positive relationship between money and price level that coincides with our data for percentage change in money and percentage change of price level. New Keynesian's on the other hand believe that prices take time to adjust and that is because they believe that some wages (contracts) have already been made and hence take time to be modified. In unanticipated change, expected prices level remains unchanged leaving the (AS) curve unchanged with only the (AD) having shifted due to expansionary policy, therefore, the economy moves to a point where the output is more than the original level.

In anticipated changes however, the expected price level increases because expectations are rational, causing wages to increase and (AS) to shift to the left. Again, like the New Classical model, (AS) does not shift completely due to rigidities and settles at a point where the price level is higher than it originally was, output also increases. It is because of this that unanticipated changes have larger effects than anticipated ones. Having said this we can see that our observations pertaining to the relation of money with the price level is coherent with the New Keynesian view.

The rising of prices however does not occur quickly for Keynesian's regard prices as not totally flexible, and so this would mean that the lagged correlation between money and price are more consistent with the Keynesian view. Whereas the contemporaneous correlation is more consistent with the Classical approach which regards prices as more flexible. Finally, the data we have calculated shows that there is no relationship between Real interest rates and percentage change in output. This data does not coincide with the Keynesian view for it regards that there are other factors that affect real interest rates other than money supply. Real interest rates do affect output and this can be shown as follows.

Keynesian's like Monetarists regard aggregate demand as downward sloping because a lower price level holding the nominal quantity of money constant will lead to a larger quantity of money in real terms. This causes interest rates to fall, making investments more profitable and thus increases. The lower price level leads to higher aggregate demand and output. As price level degrees, Real Money Demand Increases (M/P) &# 61613; and interest rate go down, resulting in increasing investment and finally producing higher levels of output. This Keynesian view however is not entirely correct because of the liquidity trap which implies that money supply will not continue to increase indefinitely if we keep lowering the interest rates. Because people are not dumb and sooner or later they will realize that low interest rates now mean higher ones in the future, they will be them reluctant to invest their money.

Therefore an increase in output by using interest rates as suggested by Keynes if true, can only be a short run phenomena as it cannot apply in the long run because people are rational and the cannot be deceived perpetually. Bibliography: world report


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Research essay sample on Real Interest Rates Factors That Affect

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