Easy Money Policy

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Easy Money Policy

Fall 2012
MGT 330
Lu Shen

An “easy money policy” is a form of policy, where a central financial authority, such as the Federal Reserve System, in the case, for the United States of America, attempts to increase the cash flow within the economy, as well as making it available, at minimal rates. The main aim of the easy money policy is to create confidence in national investments and consequently, spur economic growth. On the other hand, an easy money policy often, tends to act as a guide to inflation (Gourincha, 7). As indicated above, the basic resultant effect of an easy money policy is to keep the interest rates, at a minimum. However, discourse on the late 2000 financial crisis and other financial crises, indicate that, lower than optimal interest rates, play significant role in the development of financial crises, since, they tend to motivate the corporate market players, to engage in excessive risk taking activities. Usually, the interest rate policy, directly affects risk, when the government changes the amount of safe bonds, which the corporate market players use as collateral, in the repo market. In addition, the corporate market players are bound to augment their collateral, by issuing assets, of which, the credit rating agencies, have significantly undermined their risk. The latter situation was excessively present, prior to the 2007 financial crisis. The presence of significantly wrongly valued collateral, increase the potential of the lower than optimal interest rates, that facilitate excessive risk taking and further worsen, the severity of the recessions (Carney, 9). One significant way in which easy money policy plays its role in causing financial crisis, is through the manipulation of time value. The time value is characterized as the dynamics in value of commodities, at different periods in time (Mishkin, 8). This mainly arises, because of the aspect of time preference, in that, consumers prefer the satisfaction of various commodities in the present or in the near future, than in the further distant future. This basically means that, most of the commodities in the market contain a higher exchange value in the present, as opposed to the future. There are various factors, which determine time preference and consequently affect the value of various goods and services. The market law of diminishing marginal utility mainly controls this. Simply illustrated, the market law of diminishing marginal utility stipulates that, commodities that are under a larger supply usually have a smaller marginal utility, whereas, commodities that are under smaller supply, have a higher marginal utility. In this case, when the incomes of the consumers are relatively high, then the time preference decreases. This is in line with the truism that the higher the supply of a commodity, the higher the chances of the less urgent wants being satisfied. Therefore, when a given commodity is in large supply, then the utility is rendered small, that is, the satisfaction derived from an additional unit supply of the commodity. Consequently, private-property violations, which come in the form of government imposition of taxes, tend to marginally reduce the income of the taxpayers. Furthermore, the lesser the supply of a commodity, the greater its demand by the consumer: and consequently, the greater the consumer’s time preference on the commodity. There lies a direct relationship between the value of a given commodity in the present and that in the future. This relationship is expressed in terms of the pure interest rate. As an illustration, if the value of the dollar in a year’s time is 0.9524 of the value of the dollar at present, then the pure interest rate stands at five percent in a given year. This is calculated as (1/0.9524)-1). When people attribute a higher time preference for a given commodity, then the commodity has a higher value in the present, relative to the...
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