Essays on The Euro in Crisis: Decision Time at the European Central Bank Assignment

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The paper "The Euro in Crisis: Decision Time at the European Central Bank" is a perfect example of a finance and accounting assignment. The interest rate in Greece was expected to decline. This is because the bailout increased the money demand hence Greece money supply. Notice that in this case money supply is an exogenous variable determined by the European bank through its monetary policy. This is illustrated in the diagram below The increase in the money supply from MS1 to MS2 necessitated by an increase in money demanded causes a decrease in the interest rate from r1 to r2.

A decrease in the money supply leads to an increase in the rate of interest (International Monetary Fund, 2010). However, the increase in the money supply will cause a decline in interest rate up to a certain level upon which further increase in the money supply will not influence a reduction in the level of interest. This is called the liquidity trap of interest. Therefore, the bailout is expected to cause a decline in interest rate up to a certain level. Comment on the expected outcome of this policy on behalf of ECB.

Provide a diagram and detailed explanation on output and prices. As noted in FSB (2012), a lower interest rate encourages investment goods and since investment is a component of output, the general output increases. In addition, a decline in interest rate tends to expand the economy by depreciating the currency and raising the net exports. The movement of price level downwards causes a rightward movement of China along the aggregate demand curve. In addition, this policy prevents the depreciation of the Euro.

According to Pratt (2010), a high exchange rate of Euro will discourage import by Eurozone hence increasing the net export. This increases the output of Greece. If the government of Greece also increases (assume) the expenditure (expansionary fiscal policy) then what do you think can potentially happen to prices? A rise in government expenditure causes a rise in real GDP (Block & Hirt, 2008). In the short run unit cost increases and price level also increases. This is illustrated by the diagram below Increase in government expenditure causes real output to increase from Q1 to Q2.

The increased output causes an increase in unit costs. Firms react to increased unit costs by increasing prices hence resulting in an overall increase in the price level from P1 to P2. Overall do you think that bailout of Greece is a health policy from the perspective of ECB? The bailout of Greece is a health policy from the perspective of ECB. Failure to bail out Greece will expose it to the risk of recession. Furthermore, the uncertainty in the financial market and the financial system of Greece will cause it to face more difficulties in raising the funds required to clear its debt.

This will be compounded by the high inflation rate that will be occasioned by the decline in output. This means that the country will be faced with the risk of higher levels of the interest rate. The bailout of Greece will send a good signal to investors of the ability of Greece to service its debt (Brummer, 2011). A lower interest rate will attract investment, which will lead to an increase in aggregate output. Furthermore, the bailout prevents the pressure of depreciating the Euro against other countries.

Currency depreciation encourages importation from other countries. This disrupts production in Eurozone economy.

References

Ang, A., Hodrick, R. J., Xing, Y., & Zhang, X. 2009. High idiosyncratic volatility and low returns: International and further U.S. evidence. Journal of Financial Economics, 91 (1),1-23.

Block, S. B., & Hirt, G. A. 2008. Foundations of financial management (12th ed.). Boston, MA: McGraw-Hill/Irwin.

Brickley, J., Smith, C., & Zimmerman, J. 2009. Managerial economics and organizational architecture (5th ed.). New York: McGraw Hill/Irwin.

Brummer, C., 2011. Soft Law and the Global Financial System: Rule Making in the 21st Century. Cambridge: Cambridge University Press.

Denis, D.K. & McConnell, J. J., 2003. International Corporate Governance. Journal of Financial and Quantitative Analysis, 38 (1), pp.1-36.

FSB, 2012. Meeting of the financial stability bond in Hong Kong. Press release, 30 May 2012.

International Monetary Fund, 2010. Australia: Report on the Observance of Standards and Codes-Data Module. Sydney: International Monetary Fund.

Paterson, M., 2006. Consumption and Everyday Life. Abingdon: Rutledge.

Pratt, J., 2010. Financial Accounting in an Economic Context. New York: John Wiley and Sons.

Sloman, J. and Jones, E., 2011. Economics and the Business Environment (3rd ed.). Harlow: FT Prentice Hall.

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