MATHEMATICAL ECONOMICS

Mathematical Economics Project



Mathematical Economics Project

Executive Summary

Interest rates are no doubt an integral part of the growth of an economy. It does not only enhance the investor's interest in any financial market but lower interest rates certainly increase the overall impact of growth. It has been noticed that the recent behaviour of Banks not able or willing to pass on interest rate reduction onto their loan products has created further uncertainty in the market (Vroey & Hoover, 2004). There are various ways through which this impact can be determined on various macroeconomic variables and particularly changes the classic IS - LM model significantly. In an economy with the characteristics of a developed country, interest rate uncertainty causes very negative economic effects, especially when the exchange variations are due to purely psychological factors that encourage speculative attacks. This is because market expectations of the future value of the local currency exchange incorporate this uncertainty, which directly influences the decisions of economic agents.

The recent decision by the Monetary Policy Committee (Monetary Policy Committee), the Central Bank, which reduced the basic interest rate, caused great surprise in the financial market, as the vast majority of its analysts predicted that the rate would not change. As it says in that market, they were anchored in this prediction stability (Huang, 2008). Among other things, guide decisions regarding the allocation of resources between different applications, as well as the compensation offered to depositors. Institutions know that part of their remuneration is linked to hit analysts forecasts, which also has the effect that sustains prestigious careers. It is understandable, therefore, part of the frustration after the decision of the Monetary Policy Committee (Basso, Calvo & Jurgilas, 2007).

For this and other reasons, the reduction of the RBA was widely criticized in the financial market. Among other things, critics pointed out that the Monetary Policy Committee changed its way of deciding, from the reduction of the RBA rate increase without a break in between, thus affecting its predictability, the independence of the central bank was violated (sometimes it is a euphemism for a desired dependence on the market), that the decision was political (in which case the central bank would be dependent on the government that integrates) and the Monetary Policy Committee also took on the task of defending the level of economic activity, when it should only take care of inflation (Rosen, 2003).

Background

Fiscal policy shows its significant affects in the goods market but its major impact always targeted towards the assets markets. Because the goods and assets markets are interlinked, therefore both monetary and fiscal policies shows the effects on both the level of interest rates and output. The purpose of the contractionary or Expansionary monetary policy is that it moves along the LM curve to either left or right respectively (Young & Zilberfarb, 2009). Similarly, contractionary and Expansionary fiscal policies due to their charactersstics to move the IS curve to the left or either to right respectively.

For the working of monetary policy, central bank usually ...