The current state of the economy is one where the inflation rate is increasing, the Gross Domestic Product is increasing and there is steady job growth – all factors pointing towards economic expansion. Overall inflation figures showed a rise due to the significant hike in food and energy prices. While the Federal Open Market Committee did not alter the federal funds rate with this monetary policy, leaving it at 5.25%, the core issue it faced was the increasing inflation rate. While inflation was expected to come down to a moderately acceptable level, there was a risk that this might not occur and this was the predominant policy concern. Due to the uncertainty about future inflation and growth, later policy adjustments would be determined by information received regarding these two factors.
The increase in real GDP in the first half of 2007 was the same as that in the second half of 2006: at an annual rate of 2.25%. Though consumer spending and business fixed investment rose steadily, economic activity could not increase by the same amount due to the contraction in residential construction. Real GDP would also have increased by more had it not been for the lackluster inventory investment, a decrease in defense spending as well as a plummeting of net exports in the first quarter of 2007. However, the economy recovered from these effects in the second quarter as these figures reversed back to normal and the GDP growth rebounded.
The labor market upheld its position from last year, as hiring continued steadily, while the unemployment rate remained unchanged at 4.5%. The sectors which experienced significant job growth were the service-producing industries, specifically health, education, dining, and those providing professional and technical services. Even as real hourly compensation increased, the boost in consumer prices reduced the extent to which this increase was felt. Factors which led to consumer price inflation boosts were the rebounding energy prices (which had dipped in 20060 as well as increase in retail food prices. Core inflation did not record a change, yet the purchasing power of households was restrained and their gains in wealth limited due to rise in energy prices.
As financial market conditions remain satisfactory, investors seem to be confident about the future. Equity markets recorded significant profits, interest rates (intermediate- and long-term) increased and business borrowing continued as before. The gains that equity markets experienced were largely due to the continuing trend of corporations posting impressive profits and restoration of investor confidence in the economy. Economic and financial conditions are at the moment supportive of capital spending. Business investment also appears to be optimistic: there are solid gains to be realized on outlays on equipment and software as business output is expanding, profits are growing at an increasing pace, and financial conditions in general seem to be positive. The demand for exports of U.S. goods and services has also been growing and is expected to continue to grow favorably. However, this trend is more apparent in services, automobiles and industrial supplies and not so much in exports of capital goods.
Expansion at a moderate rate is expected in latter half of 2007 as well as in the coming year. Inflation is a major deterrent for future policy but is expected to reduce during the course of the next year and a half. In the long run as well, the inflation rate is not expected to increase by a lot. This is because a number of factors which pushed up inflation have disappeared or are expected to do so. For one, demands on resource utilization are expected to relax and secondly, the futures market reflects that energy prices as well as prices of other commodities will not influence inflation in the near future. Additionally, while unit labor costs might have been increasing in the non-farm sector, generally the difference between markup of prices and unit labor costs is currently substantial enough for firms to absorb these higher costs by cutting down of profit margins.
All factors withstanding, the Federal Reserve is still concerned about the possibility that the above expectations regarding inflation moderation might not be met. This is partly because the optimistic expectations might have been derived from factors which might be short-lived or inconsequential. Also, economic demands on resource utilization might remain at the same high-pressure level, which is likely to maintain the upward inflation trend. Costs could also be driven up by other forces, such as higher energy prices, increase in other commodity prices or an unchanging or snail’s pace growth in structural productivity. Another possible scenario is that as present high rates of inflation are prolonged, expectations of long-term inflation will rise and this itself will further drive up inflation.
The Federal Reserve decided to leave its monetary policy unchanged and due to the ‘uncomfortable high’ inflation level prevalent, maintained the federal funds rate at 5.25%, last increased by 0.25% in 2006. There has been an increasing trend in this rate since 2004 and generally reflects an attempt to restrain inflationary pressures on the economy.
References
FRB: Monetary Policy Report to the Congress. Retrieved, September 7, 2007 from the Federal Reserve Website.
The policy of dollarization is widely used around the world as the main tool to reduce inflation rates, stabilize local currency and the elimination of exchange rate risk. The process of dollarization is connected with stabilization which precedes structural policies aimed at increasing the efficiency of the economy. In many emerging economies, in the absence of a government which has the political strength to stabilize, the legalization of dollarization is advocated, as this limits the authorities’ ability to fix prices administratively or to obtain purchasing power through the printing press.
In general, ‘dollarization’ means the substitution of hard currency for the domestic currency as the medium of exchange, and above all as the store of value, in a large part of the domestic economy, so that the country effectively adopts a dual currency system. The term ‘dollarization’ is applied to any foreign currency used as the national currency. Following Schmitt-Grohe et al (2001): Proponents of dollarization argue that, by eliminating devaluation risk, dollarization will go a long way toward reducing country risk premia, thus lowering aggregate volatility” (p. 482). Dollarization means a currency union in which countries create a new currency supported by new institutions. The examples of this process are euro currency and the European Central Bank (Hinds 2006).
The process of dollarization
The process of dollarization can be unofficial, semiofficial and official (Levy and Sturzenegger 2002). “Full dollarization is a complete monetary union with a foreign country from which a country “imports” a currency by making the foreign currency full legal tender and reducing its own currency, if any, to a subsidiary role” (Bogetic 2000, p. 17). The main countries which follow official dollarization policy are Ecuador, El Salvador, and Panama (US dollar).
Also, euro dollarization is typical for Kosovo, Monaco, Andorra, etc. The New Zealand dollar circulates in Cook Islands, Nine, Tokelan and Pitcarn Island. The Australian dollar is an official currency in Kiribati, Nauru and Tuvalu (Levy and Sturzenegger 2002).
Positive sides of dollarization
The advantages of ‘dollarization’ are, first, that enterprises and individuals are provided with a currency (or currencies) whose value is more or less constant, thus reducing the degree of risk involved in economic calculations. In this way one of the main real costs of inflation, and one which probably increases the natural rate of unemployment, is avoided. Second, enterprises (both socialized and private) are able to import what they need directly from the outside world, without having to go through the lengthy process of obtaining approval for hard currency from the central authorities (usually the central bank) (Eichengreen, 2002). Not only are such decisions taken slowly, but their quality is likely to be lower than that of decisions taken by the enterprises directly affected. Following Edwards and Magendzo (2006):
Dollarization will positively affect growth through two channels: first, Dollarization will tend to result in lower interest rates, higher investment, and faster growth. And second, by eliminating currency risk, a common currency will encourage international trade; this, in turn, will result in faster growth (p. 269).
‘Dollarization’ is usually introduced in countries suffering from hyperinflation. The benefits of this are that individuals and enterprises (both private and socialized) have access to currencies that retain their value and which allow them to compare domestic costs with those on world markets. Eichengreen (2002) underlines that dollarization “strengthen the financial sector, … improve the fiscal balance, harden the government’s budget constraint,.. and enable the government to lengthen the term structure of its debt” (1).
‘Dollarization’ would also make inflation self-limiting to some degree. The higher the rate of inflation, the larger the sphere of activity that actors would choose to carry on in hard currency, and thus the less the impact of inflation on the real economy. This would be an accelerating process (Eichengreen, 2002). As the number of activities affected by inflation declined, the ‘inflation tax’ on these activities for a given budget deficit would have to increase, inducing activities to switch even more rapidly to the hard currency economy.
Economists speak about one more form of dollarization which can be used to stabilize economy and local currency rate. According to Broda and Yeyati (2006):
Financial dollarization can take several forms, including foreign borrowing (domestic banks or local firms borrowing directly from abroad as in the case of Thailand and Indonesia in the 1990s or Chile and Argentina in the early 1980s) and deposit dollarization (domestic asset holders saving locally in foreign-currency deposits as in Turkey and Argentina in the 1990s)” (p. 963).
What will accelerated inflation lead to?
Acceleration of inflation can be expected to lead more actors to opt out of the inflationary economy in a multi-currency system. In such an economy, if exchange rates between currencies are flexible, then Gresham’s law does not hold. Indeed, the better money (the one which is less inflation-ridden and whose purchasing power is less impaired by shortages of goods due to controls on prices which it is used to denominate) will displace the worse (Levy and Sturzenegger 2002).
A government which finances a budget deficit caused mainly by widespread subsidies to loss-making enterprises by printing money will find that people paid in the domestic currency are facing more and more transactions which have to be carried out in hard currency, and that the free-market value of the domestic currency is falling. Inflation thus becomes self-limiting. As more and more of the nonsubsidized activities switch into hard currency, the pool of profitable activities which take place in the domestic currency, and which are effectively taxed by the printing of money to pay for the subsidies to loss makers, will constantly decline (Eichengreen, 2002).
As the ‘inflation-tax base’ declines, the ‘inflation-tax rate’ increases, speeding up the process by which profitable activities switch to the hard currency economy. In the end only loss-making activities would be financed in the domestic currency. Once this situation was reached the domestic currency would have literally no value. The authorities could therefore be expected either to pursue a less expansionary monetary policy before this stage was reached, or to prevent certain profitable activities from switching to the hard currency economy by administrative decree, which would be a form of direct impost upon them. “dollarization levels can remain high, in spite of disinflationary policies, if the expected volatility of the inflation rate is high in relation to the volatility of the real exchange rate” (Duffy et al 2006, p. 2073).
As long as most of the profitable part of the economy used hard currency, it would be fairly visible who was paying the inflation tax. This might lead to countervailing political pressure, or to the profitable domestic currency sector simply being smaller than it otherwise would have been (Jameson, 2003).
The sources of costs associated with dollarization involve:
the loss of seigniorage revenue,
the lack of a lender of last resort,
the country loses its ability to conduct cyclical monetary policy.
Following Schmitt-Grohe et al (2001): when a country adopts the U.S. dollar as the sole legal tender, the stream of its seigniorage revenue begins to flow to the U.S. central bank. Clearly, the magnitude of the cost of dollarization stemming from the loss of seigniorage revenue for emerging market economies depends on their ability to negotiate a seigniorage sharing agreement with the United States” (p. 482).
Dollarization of necessity involves a cost: the ‘seigniorage’, which is paid to the suppliers of the hard currencies. The example of economic policy in Poland and Yugoslavia during 1990s vividly portrays the process of dollarization. To circulate in Poland and Yugoslavia US dollars have to be obtained, ultimately from the central banks of the United States. They can only be obtained in exchange for goods and services, yet they are then used for exchange, and as stores of value, by Polish or Yugoslav residents, so that they are not used to purchase US goods.
Naturally, a single dollar may circulate many times a year, thus facilitating transactions worth several times its value in that period (Levy and Sturzenegger 2002). Nevertheless, the cost of seigniorage remains, whereas countries whose governments are capable of providing their citizens with a stable currency do not have to pay it. Seigniorage costs already represent a significant amount. In Poland probably some $7 billion are held by the population in hard currency bank accounts and cash, an increase of some $5 billion since 1982, or $700 million per annum, which is between 0.5 per cent and 1 per cent of GNP per annum in purchasing power parity terms (Levy and Sturzenegger 2002).
However, in the absence of a successful anti-inflationary policy, the attempt to do without a second, ‘hard’ currency would lead to even higher costs due to the disruption of economic activity which would be caused by a hyperinflation from which there was no easy shelter. For instance, the case of Panama shows that
Official dollarization may have favorable distributional benefits. In the environment of a weak national currency, the young, financially sophisticated, and wealthy are often better able to preserve and expand their wealth during periods of high inflation than are the old (such as pensioners), the poor, and, generally, people living on fixed incomes” (Bogetic 2000, p. 17).
The process of dollarization is known from many countries suffering from hyperinflation, Argentina at present and Israel in the early 1980s being examples. Dollarization is, at present, only relevant to the two market socialist countries. which are affected by hyperinflation (Bogetic, 2000). China and Hungary have the possibility of bringing inflation and excess demand under control, and then moving on to convertibility of the domestic currency.
Although the present author is not optimistic as to their likely success, dollarization is very much a cure of last resort. Dollarization is made easier in Poland and Yugoslavia by the fact that both countries have large numbers of their nationals working abroad (Levy and Sturzenegger 2002). These send home remittances if they are permanently domiciled abroad, or return home with their accumulated hard currency earnings after periods of temporary, often illegal, work in the West (Hinds 2006).
By 1987 in Poland the majority of savings deposits and cash held by the population were in hard currency (valued at the black market rate of exchange). If inflation continues to gather pace, this proportion will increase further, as individuals and private businesses switch to currencies which devalue far less, for use as stores of value and even media of exchange for larger transactions (such as house, car or machinery purchases). Many private businesses have used hard currency as their unit of account for years (Levy and Sturzenegger 2002). Current inflation and shortages, due to repressed inflation, have also led many socialized enterprises to insist on part payment in hard currency in both Poland and China, and such practices can be expected to expand if inflation accelerates further (Bogetic, 2000).
Unofficial dollarization has a great impact on exchange rate of the local country. Following Jameson (2003), unofficial dollarization occurs under three circumstances:
“When there is ample availability of dollars to the domestic economy. When domestic instability affects the health of the financial system and the confidence of domestic economic actors. When government policy allows a dollarized sector to exist within the domestic economy” (p. 643).
In this case, a central concern for economists analyzing forex black markets has been to determine the impact of these markets on national governments’ ability to carry out monetary policies such as money supply and aggregate credit management, as well as exchange rate policy (Eichengreen, 2002). The primary focus has been on the black market’s relationship with domestic inflation. Following Duffy et al (2006): “Unofficial ” dollarization ” has become a pervasive phenomenon in many emerging market economies. … [It means] unofficial currency substitution, i.e. the competition between U.S. dollars and the domestic currency as a medium of exchange” (2073).
If the black market allows excess demand for foreign exchange to move out of the official market, then it may also permit the pricing of imports to reflect their black market cost rather than their official market cost (in local currency). This condition greatly lessens the government’s ability to deal with inflation through exchange rate policy. The larger the country’s international sector, the more serious is this concern.
Impact on credit policy by dollarization
The dollarization processes have a crucial influence on credit policy because in addition to the direct exchange rate effects of black markets, and the subsequent effects on inflation, there are key monetary policy effects through alteration in the availability of credit. When the black market is used to bring added foreign exchange into the country, and when that foreign exchange is partially used as domestic currency (dollarization), then the money supply has effectively increased (Eichengreen, 2002). For instance, in Argentina despite the number of pesos remaining constant, the full money supply available to the public rises with the added dollars.
This implies an inflationary pressure in the local economy, unless the central bank intervenes to take currency out of circulation (Velde and Veracierto 2000; Hinds 2006). To complicate matters further, the money supply becomes less manageable as the dollars grow in proportion of total money, since the central bank cannot control the amount of dollars in circulation. For instance, “In order to dollarize, Argentina has to buy noninterest-bearing dollars with the interest-bearing reserves it has accumulated. These reserves bear interest at present, and therefore are a source of income for Argentina (seigniorage)” (Velde and Veracierto 2000, p. 24).
Dollarization has been observed throughout Latin America from 1970 to 1990. In cases such as Peru and Bolivia, estimates of annual cash U.S. dollar inflows during the late 1980s in each country exceed $US 1 billion. In relation to domestic money supplies, these figures are substantial amounts. These problems are compounded by the common phenomenon of capital flight, which takes local wealth out of the country (often through the black market) and places it in overseas safe havens. In this way, dollars are leaked out of the country in exchange for financial claim, such as bank deposits (Velde and Veracierto 2000; Jameson, 2003).
Likewise, further down in the credit chain, black market dollar holdings overseas may expand the availability of dollar credit to those holders. Thus, a local resident with an overseas dollar deposit account may be able to secure credit for use in the local economy, again outside of the control of the local monetary authority. None of the macro models available is able to handle these multiple complications together, although some models do treat some of them (Hinds 2006).
The high and hyperinflation that market socialist economies are experiencing does matter economically and politically. Inflation is destructive of enterprises’ and individuals’ ability to make economic calculations, so that its disruptive effects become more severe as the economy is reformed in a market direction and relies less on administrative control (Hinds 2006). Western evidence, limited as its use inevitably is, suggests that whatever the proximate causes of inflation in the market socialist countries (e.g. government policy to raise consumer goods prices so as to reduce consumption for international payments reasons in Hungary), the underlying reason is the maintenance of the actual rate of unemployment far below the natural rate (Eichengreen, 2002).
Given the extremely high degree of rigidity in these economies the natural rate of unemployment could well lie in the range of 20-30 per cent. Since it is far from certain whether inflation can be stabilized at rates of 60-195 per cent, the actual rates of unemployment required in these two countries to bring inflation under control could be considerably higher. Unemployment at these levels may be politically unacceptable in countries which have had very little experience of unemployment over the past four decades (excepting Yugoslavia) (Schmitt-Grohe et al 2001, Levy and Sturzenegger 2002).
The main problem for local economies is that the extensive dollarization has prompted even greater interest in the forex black market. As local currencies have devalued, sometimes drastically, many Latin American individuals and institutions have searched for a safer store of value (Hinds 2006). The U.S. dollar, though not wholly stable or able to maintain its purchasing power relative to European and Asian currencies in recent years, has generally maintained its value in terms of Latin American currencies from 1960 to 1990 (Levy and Sturzenegger 2002).
By holding some of their wealth in dollars and/or dollar-denominated financial instruments, Latin Americans have been able to preserve that value in contrast to holding local currency instruments. Because access to dollars in the official market has been frequently restricted, the black market has served the function of providing this access (and also providing the service of transferring funds overseas to “safe” havens such as the United States) (Levy and Sturzenegger 2002)..
This is a complex issue, since in many of the countries, dollarization of the economy has led in past decades to use of U.S. dollars as an acceptable or even preferred means of settling domestic financial claims. Thus, the de facto money supply includes both dollars as well as local currency in circulation in many instances (Hinds 2006).
Conclusion
In sum, dollarization is widely used in emerging economies as the main method to reduce inflation rates and stabilize local currency. This policy proposes both benefits and threats for local economies including low inflation rates but lack of financial and monitory control over the local currency. Thus, dollarization is considered vital to eliminate the monetary financing of the budget deficit, while a significant degree of discretion is usually maintained in the creation of credit for non-government (CNG) by the banking system.
References
Bogetic, Z. (2000). Full Dollarization: Fad or Future? Challenge, 43 (2), 17-19.
Broda, Ch., Yeyati, L. (2006). Endogenous Deposit Dollarization. Journal of Money, Credit & Banking, 38 (4), 963.
Duffy, J., Nikitin, M., Smith, T. (2006). Dollarization Traps. Journal article by John, Journal of Money, Credit & Banking, 38 (8), 2073.
Edwards, S. I., Magendzo, I. (2006). Strict Dollarization and Economic Performance: An Empirical Investigation. Journal of Money, Credit & Banking, 38 (1), 269-278.
Eichengreen, B. (2002). When to Dollarize. Journal of Money, Credit & Banking, 34 (1), 1-10.
Jameson, K.P., (2003), Dollarization in Latin America: Wave of the Future or Flight to the Past? Journal of Economic Issues, 37 (3), 643.
Hinds, M. (2006). Playing Monopoly with the Devil: Dollarization and Domestic Currencies in Developing Countries. Yale University Press.
Levy, E., Sturzenegger, F. (2002). Dollarization: Debates and Policy Alternatives. The MIT Press.
Schmitt-Grohe, S., Uribe, M., Zarazaga, C. E.J.M. (2001). Stabilization Policy and the Costs of Dollarization. Journal of Money, Credit & Banking, 33 (2), 482-485.
Velde, F.R., Veracierto, M. (2000). Dollarization in Argentina. Economic Perspectives, 24 (1), 24.
Inflation can affect fixed-income investments when interest rates rise. Central banks frequently set inflation objectives, and if inflation rises above the acceptable level, interest rates may be raised by the officials in charge (Szyszko 288). Investment returns on current fixed-income assets typically drop when they become less competitive than newer, higher-rate fixed-income assets. In other words, interest rates and the prices of fixed-income assets are inversely related. Inflationary effects can also cause damage to fixed-payment strategies. Due to rising inflation, investment returns usually lose purchasing power since most fixed-income investments have the same interest until maturity.
Inflation is a major concern for investors since it harms real savings as well as returns on investments. Investors aim to improve their buying power over time, but inflation gets in the way because investment returns must stay up with inflation in order to increase real purchasing power (Mahlstedt and Zagst 9). An investment that is predicted to return three percent before inflation in a four percent inflation scenario will result in a negative return when accounting for inflation. In situations when investors do not safeguard their investments, fixed income earnings may be harmed by inflation. Many investors purchase fixed-income assets to receive a consistent income stream of interest or coupon payments.
Investors must use short-duration methods to lower interest rate sensitivity to deal with inflation in fixed-income portfolios. Using a short-term approach to reduce a portfolio’s sensitivity to rising interest rates may limit volatility or losses when the interest rates are high (Antonacci et al.1152). The short-term approaches are useful in generating excess returns by focusing on short-dated corporate credit or using a wider set of return drivers as spreads or currencies. The rise of inflation from low levels act as an indicator that the economy is stable. A performing economy benefits corporate credit spreads since defaults are expected to be at low levels.
In addition, Absolute Return Fixed Income (ARFI) approaches provide investors with access to a wide range of global opportunities. When combined with flexible investing tactics, for instance, hedging and a larger focus on alpha to help produce returns, they are expected to negatively correlate with the overall trend of interest rates and credit spreads. ARFI strategies are generally liquid, although they contain a wide range of investment methodologies as well as large disparities in performance among managers due to the breadth and flexibility of mandates (Byström 50). As a result, investors may want to consider implementing a multi-manager approach.
Moreover, transferring a portion of the investment to assets with risk-free coupons can be used to lower interest sensitivity without lowering expected returns. This transfer of investment portions ensures that exposures are appropriately diversified, hence protecting investors in cases of high inflation (Rush 36). Loans as well as securitized assets, like mortgage-backed securities, are illustrations of this. However, investors should be mindful of the numerous dangers of investing in these resources, which are usually considered less liquid as well as sophisticated than traditional fixed-income products.
Many investors, particularly pension plan sponsors, underfunded find the low-yield environment problematic, especially when they need to “catch up” while managing risk at acceptable levels. Pension plan sponsors may face issues as interest rates are likely to rise. By taking a diversified approach to fixed income investing, investors can better manage the risks associated with interest rates as well as inflation and increase the yield in their bond portfolios.
Multinational corporations consider inflation, purchasing power parity, and interest rates while deciding to borrow in that or this country. When a company borrows in a country with higher interest rates, the risk of inflation and currency depreciation grows, but the debt of this company is the same (Egilsson, 2020, p. 451). Even if the price level changes, the company will benefit from borrowing in countries with high-interest rates. Moreover, an international corporation might decide to borrow from a country with high-interest rates because it will increase its home currency’s demand and value.
If a company understands that it receives a higher return on equity from such an operation than it can get from borrowing in a country with low-interest rates, it will borrow in such countries like Brazil. In comparison, countries with low-interest rates, like Switzerland, offer a low return on equity due to low economic growth. If rates are too low, they will cause excessive growth and inflation (Seabury, 2021). No matter how much money a company needs to borrow, it will loan the same sum in different countries, so the choice of a country with high-interest rates will be more beneficial.
I agree with you that inflation rates may influence an international company’s decision to borrow from Brazil rather than Switzerland. Inflation will lead to a higher price level and currency depreciation, but it will also strengthen a firm’s local currency (Egilsson, 2020, p. 462). As a result, when it needs to return its debt, the sum will be the same, but the Brazilian currency will be depreciated, benefiting the corporation.
As to the financing advantages of multinational businesses, I agree that they are more flexible. Other advantages are access to global markets, cost efficiency, and a diversified workforce. Such companies can choose in which country to borrow or invest, produce new products, and hire workers. I also agree that TFC may wish to do business in Switzerland and Brazil. However, I think it can invest in both these countries and China because its currency and trade esteem is perfect for the U.S. dollar. China has a developing economy and great potential for growth and extension.
This paper highlights the difference in the projected social security benefits income and the buying power of the income based on a given inflation rate. The report will also outline whether individuals can survive only on handouts from social benefits alone. I will also cover some of the significant measures and initiatives an individual can undertake to increase their income to maintain their living standards.
Projected Social Security benefits at the retirement age of 65 years are 48,580
The current age is 25 years
Retirement age is 65 years (65-25) =40 years
The annual inflation rate is at 3%
Utilizing the above information to calculate the projected decrease in the value of the dollar due to different effects of inflation, it is evident that;
Based on an inflation rate of 3.00%, the value of $48,580 will be reduced to $14,892.53 in 40 years which portrays how inflation rates have a great impact on the dollar’s value.
Annual Benefits
Sadly, surviving on a projected future income of $48,580 would be equivalent to an individual living on an income of $14,892.53 at retirement. Inflation plays a significant role in determining the value of the American dollar since any slight alteration in the inflation rate brings about a corresponding change in the dollar’s strength. The value of social security benefits is not subject to any shift in the rate of inflation (Townes, 2019). The value will not change to cover up for a negative shiftin inflation, increasing the cost of living (Townes, 2019). At retirement, the Social Security benefit will not be enough to cater to my living standards, which requires an individual to have alternative sources of income.
The Possibility of Surviving on the Projected Social Security Benefits
Surviving on a Social security benefit of $48,580 at retirement would be challenging because the purchasing power and the dollar’s value have greatly decreased as the wants of the retirees keep on increasing. Human wants tend to be insatiable and hence keep on recurring in different aspects of life (Townes, 2019). Some of the major areas where an individual needs to invest more financial resources to live a comfortable and sustainable life include proper housing, food, and quality healthcare. The main impact inflation has on the value of the American dollar is that it decreases the value over a given period of time (Townes, 2019). This is because inflation increases the cost of goods and services required for survival. When the dollar’s value drops, the number of goods and services that can be bought using the dollar also decreases.
Factors to Consider for Acquiring other Sources of Income and Ensuring Proper Utilization of Financial Income
Financial Literacy
One of the major factors that I will ensure is adhering to financial literacy principles to enable me to manage and account for all my financial resources. Financial literacy is the possession of the appropriate set of skills and knowledge on how to effectively financial resources (Borzykowski, 2020). Acquiring the appropriate knowledge of financial literacy will enable me to make proper investment decisions which will help me achieve long-term goals. Long-term goals involve investing huge amounts of financial resources towards creating lifetime or generational wealth. Generational properties such as businesses are investments that will bring constant returns to an individual even after retirement (Borzykowski, 2020). Directing financial resources towards profit-making initiatives is one of the main ways of generating money to cater to your living standards.
Investing in Family and Insurance Coverage
Investing in the young generation is also one of the major factors that contribute to an individual’s better living after retirement. The younger generations are the individuals who will take care of the elderly people and other special needs individuals within the society. Investing in their needs, such as education, will enable them to have a better livelihood and have the capacity to care for the elderly appropriately. Ensuring an appropriate lifestyle while still at a younger age is also another major way to acquire a peaceful retirement lifestyle (Borzykowski, 2020). This involves investing in healthcare insurance packages that would be effective even after retirement.
Investing in Retirement Schemes
Investing in other different retirement schemes is also a better way of helping clients secure their future. There are organizations licensed by the government that is allowed to collect individuals’ monthly retirement contributions (Townes, 2019). Most such organizations have been awarded tax breaks for imposing on their clients to motivate them to save for their retirement. The government has also encouraged employees to ensure that a certain percentage of the employees’ salaries should be channeled toward retirement benefits.
Investing in Annuities
Investing in annuities is also a major factor to consider when having an affordable retirement lifestyle. Annuities are considered effective because they are not exposed to any form of market risk, and they have a guaranteed fixed rate of return. Investing in life insurance is another significant approach to having a stress-free retirement life. Life insurance majorly aims to retain an individual’s financial state if they lose their jobs or have an accident (Townes, 2019). An individual pays a monthly premium that will be utilized to indemnify them in case of retirement.
To conclude, Social Security benefit funds are not sufficient to be utilized as the only source of income after retirement. The government only gives out handouts to individuals because they do not have additional sources of income, and they make up the vulnerable groups in the community (Borzykowski, 2020). Individuals are encouraged to start considering adopting proper retirement plans, which will enable them to have a smooth transition into the retirement period.
Treasury inflation protected security refers to the type of security aimed at protecting investors in the financial market from impact of inflation. The United States government backs up this security. This form of investment has a lower risk levels compared to others. The parity value of TIPS increases with the increase in inflation level. This value is determined by the consumer price index while the rate of interest is fixed and is paid twice annually.
At maturity of the security, the treasury either pays the interest adjusted standards or the original amount whichever is higher. The bonds are usually adjusted daily despite the fact that, the accumulated amount of interest can only be reimbursed on maturity. Another attribute of this security is that, it has the allowance of adjusting to inflation. Hence, the interest earned from this can be considered as real yields rather than nominal.
In most of the treasuries, the nominal interest yields are normally a product of three sources; the real yield, an additional yield that compensates for expected inflation and an inflation risk premium” (Fabozzi 225). It is not however, to quantify the real payments for the treasury bonds owing to the undetermined inflation rate. The extra yield therefore, disbursed to the investors is a compensation of this uncertainty in inflation rates.
Tips, however, tend to provide investors with a high level of certainty by offering two yields; the first one being the real yield, and the second one the yield representing the trailing inflation which is based on the consumer price index” (Fabozzi 226). This ensures that the real rate of interest is determined beforehand, and it adjusts automatically to the increase in the inflation rate. Tips are unique owing to the clarity of their rate of return that can be predetermined. As a result, “the investors are able to determine the risk of value erosion of a bond’s principal and any future interest payments caused by an unanticipated increase in inflation” (Jarrow and Yildiray 338).
The United States government first offered TIPS in 1997. This happened to be the largest TIPS market in terms of the nominal quantity of the treasuries and its absolute market value. This was brought about by the need to protect the economy from inflation by delivering a fixed rate besides the inflation-adjusted amount. It was meant to provide a cushion for the consumer’s purchasing power that is usually affected most by inflation.
Besides this, “they provided portfolio diversification benefits owing to their low correlation with the other classes of assets” (Jarrow and Yildiray 340). Since they were introduced in the US financial market, they attracted a massive number of investors and policy makers in a unique method never been experienced before. The fact that they were free from credit risk also served as an assurance to investors in the United States.
The TIPS market has portrayed a magnificent growth since its inception. Their market value has grown from the zero percent at the time it was established to approximately 17.5% in twelve years. This is an indication of exemplary performing considering the great fluctuations experienced in the financial markets. The nominal yield of TIPS has been displaying a statistically high average value compared to the treasury’s yields.
This difference could be a result of the strategy used in TIPS administration of increasing the cost of borrowing instead of decreasing it. “The real yield of TIPS is averaged at 2.8% with a low standard deviation of 0.88%, consistent with the inflation protected nature of TIPS” (Fabozzi 213). According to the US government treasury data, the daily turnover for these securities is at 1.8% and this is lower than the other securities standing at an average of 13%.
Works cited
Fabozzi, Jafferson. Bond Markets, Analysis and Strategies, 4th ed. Upper Saddle River, NJ: Prentice Hall, 2000. Print.
Jarrow, Robert, and Yildiray Yildirim. “Pricing Treasury Inflation Protected Securities and Related Derivatives Using an HJM Model”. Journal of Financial and Quantitative Analysis 38.2 (2003): 337-358. Print.
The main argument in the article Inflation hits the fastest pace since 1981, at 8.5% through March is how Inflation is significantly increasing. Due to this increase, the current inflation rate in the U.S. is at 8.5%, and it is heavily linked to hiking prices of gasoline across the world. Initially, the inflation rate was moderate due to demand and stubborn pandemic–related shortage of supplies, but the war in Ukraine has worsened the situation. The disruption of supply and military conflict in Ukraine has led to an increase in the prices of fuel and groceries (Smialek, 2022). Although Inflation has hit hard on households because a significant share of their budgets is being used on necessities, economists and policymakers have predicted that Inflation in goods will stabilize. Decrease in used car prices and apparel, and government measures, are the reasons for predicting stabilization. Some of the measures being put in place by the government are the possibility of banning sales of higher-ethanol sales. Generally, the U.S. is experiencing one of the fastest increasing inflation rates caused by hiking prices of gasoline. Has Federal Reserve is trying to stabilize.
In my opinion, the article is relevant because it discusses Inflation and its effects on both the government and households. When it comes to the government, inflation forces us to take measures that will moderate it. On the other hand, families are affected by an increase in the prices of necessities. Additionally, the journal is relevant to macroeconomics concepts such as demand & supply, Inflation, Consumer Price Index (CPI), and price levels. First, it is relevant to the demand & supply concept as it discusses how strong demand and supply shortages have been caused by the pandemic outbreak (Smialek, 2022). Secondly, the inflation concept is discussed in the entire article as it tries to show the previous rate and what people should expect in the future. Thirdly, the CPI concept is demonstrated in the monthly report by Labor Department that reveals fuel prices have jumped to record levels and grocery costs soared. Finally, the price levels concept is identified when it indicates that the fuel prices have record increase levels.
Economists’ and policymakers’ predictions are crucial as they give households hope that prices of necessities are likely to reduce. Additionally, their predictions show the leading causes of the fastest inflation rate since 1981 (Smialek, 2022). Further on, the predictions reveal that the inflation rate is expected to stabilize due to a decrease in the price of used cars and apparel. The predictions of economists and policymakers are in line with the economic forecasting concept as it tries to predict the future condition of the economy using widely followed indicators such as gasoline. In addition, while doing economic forecasts, some statistical models are usually developed and used on other macroeconomic concepts. The models developed can be used to forecast interest rates, retail sales, and gross domestic product growth rates. Generally, the economic forecasting concept is fundamental as it is used in different ways apart from being used as an indicator. Therefore, the federal government should always use economic predictions as a reference while developing interventions as they have an in-depth analysis of macroeconomics.
From another perspective, the volatile concept is primarily applied in the article. For instance, it argues that a measure that strips out volatile food and fuel prices decelerated slightly in February, decreasing used cars and apparel prices. This argument showed that food and fuel prices have become highly volatile due to the fast inflation rate, but it looks like February has been a good month due to moderate Inflation (Smialek, 2022). Further on, the article reveals that the inflation rate is at its peak, leading to an increase in the national average gallon of gasoline. In March, the volatility of necessities will be high, and households will spend a larger share of their budget purchasing them. There are numerous risks when needs become highly volatile in an economy. The main customers will reduce their spending habits, leading to the closure of businesses that are not offering products and services that are basic needs. Another risk is that there will be a decrease in investment and output for export products due to rising uncertainty. Therefore, high food and fuel price volatility will affect the work, reducing gross domestic products.
The author of the article “Inflation hits the fastest pace since 1981, at 8.5% through March” uses the volatility and economic prediction macroeconomics concepts to explain how Inflation in the U.S. is at its peak. The volatility concept is used to show the unpredictable increase in gasoline prices. This has affected the entire economy; the CPI has indicated a rise in groceries price. In most cases, when there is a high volatility rate of basic needs like is being experienced in the U.S., households tend to reduce their expenditures to ensure that they afford the necessities (Smialek, 2022). On the other hand, economic prediction reveals the previous inflation rate and what they expect in the future. The author shows that the inflation rate in March was at its peak, but it is expected to slow down due to intervention by the Federal Reserve in the coming few months. It is crucial to note that the economist considers numerous factors before economic prediction.
In general, the fastest inflation rate that the U.S. is facing due to the hiking prices of gasoline is significantly affecting households and the government. In households, the cost of necessities such as groceries has become highly volatile. This has led to people reducing their spending habits, and if this persists, some businesses will be forced to close down. On the other hand, the government is being affected by threats of being voted out because they feel that the Federal Reserve is not doing its work of controlling Inflation (Smialek, 2022). Although the government is putting in measures to moderate Inflation, it is yet to affect the increase. The rates are expected to increase in the future, but there is no assurance as the war in Ukraine does not have an exact date of ending, and new closedowns have started to emerge in China.
In conclusion, it is not the U.S. only experiencing the fastest pace of Inflation; this is a worldwide issue. Some countries are experiencing a severe rate of Inflation that has led to a shortage of gasoline. This fast pace of Inflation has been caused by factors such as current lockdowns being experienced in China, the war in Ukraine, and the economic recession of countries after suffering from disruptions caused by Covid-19. Therefore, the U.S. is performing well because the Federal Reserve is trying to stabilize the inflation rate.
Reference
Smialek, J. (2022). Inflation hits the fastest pace since 1981, at 8.5% through March. Nytimes.com. Web.
During these challenging times, politicians and authorities of numerous countries around the world are doing their best to improve the economy of their states. As noticed in an article published online in The Epoch Times on June 20, 2022, Canada is not an exception. According to the report, in order to protect the country from the long-lasting consequences of the COVID-19 pandemic and the recently emerged effects of the Russian-Ukraine war, Canadian policy-makers implemented fiscal policies, but their efficacy is questionable.
Before discussing the article, it is essential to recall the definition of fiscal policy. This term refers to the use and adjustments of taxation and government spending in order to affect a state’s economic conditions and address unemployment and inflation. Nevertheless, as mentioned by Chen, precisely inflation is an unforeseen consequence of the implemented fiscal policy. To be more precise, the article’s author quotes Scotiabank that states that the Canadian fiscal policies are indeed the primary cause of inflation (Chen). While it is partly the duty of the country’s government to address the issue, the Bank of Canada is presently solving the problem alone. At the same time, as noticed by Chen, “better coordination of monetary and fiscal policies in Canada could lead to a return of inflation to target with less impact on the private sector.” Finally, government spending should also be cut significantly so that the private sector does not carry the disproportional burden of policy adjustment.
The article published in The Epoch Times demonstrates that fiscal policy can also have its own disadvantages and weaknesses. If implemented uncontrollably, in the wrong way, or during challenging times, this policy can lead to the growing rates of inflation, which will then require more strenuous efforts and steps. Therefore, in order to solve the new issue, the Canadian government now needs to revise its spending and reconsider the effectiveness of the fiscal policy.
Work Cited
Chen, Andrew. “Canada’s Fiscal Policy-Makers Are ‘Doing Nothing of Significance’ to Slow Inflation: Scotiabank.” The Epoch Times, Web.
Changes in interest rate and inflation affects the debt financing of corporations. Interest rate and debt financing has positive correlation. As interest rate rises, demand for debt falls as cost of capital will increase and growth rate decline. On the other hand, falls in interest rate may cause higher rate of inflation. Therefore, there is a positive relationship between interest rates and inflation. Empirical studies shows when inflation rate is grown up, among several factors rise in interest rate is common phenomenon. Falling in interest rate causes demand for goods, exceed supply, and raise inflation rate as industrial production is going down.
Thus, positive and negative relationship exists between interest rate and inflation. As interest rate changes investor changes the market movement. If money market cannot provide enough return for investors, they will tend to move their fund to capital market. So, new point of equilibrium is established. Therefore, in this way, the debt structure has changed over the period.
General Overview From the Analysis
Netherlands is facing no trouble as growth rate in industrialisation is rising through slight rise in inflation rate. Among various signs, housing sector is in a terrific condition as many of houses are unsold and number of new mortgage approvals has dropped. Consumer confidence level sharply declined. Therefore, the central bank has taken the decision to cut the current Interest rate. The relationship between interest rates is less amount of perfect positive closer relationship. The correlation coefficient is almost 31%-40% in every corner. It indicates, as Interest rate is going down, Netherlands currency is deprecating against USA currency and vice versa.
The R Square means that the variation in the dependent variable has explained by the independent variable. As Interest rate has dropped, people can borrow more money from financial institutions. As a result, the consumption level will increase than existing level.
To meet up the demand, production will increase as manufacturers can boost up money supply by injecting capital. On the other hand, it may not be possible to meet the entire or specific demand. The people and manufacturers will tempt to import goods, raw materials, services from abroad like USA. Consequently, a great portion of foreign reserves would be lessened. As demand for US$ dollar is high and supply is limited a new equilibrium point will be established by deprecating the value of Netherlands currency.
As Interest rate has dropped, depositors from USA will not incline to invest in Netherlands banks reasoning fixed return is lower. They will tend to move their money elsewhere. In these circumstances, the inflow of USA currency and reserve against Netherlands will decline. As EURO has developed, there is less reliability on US currency. In context with demand-supply theory, currency will be deprecated against USA currency. As a result, the debt pattern would be changing.
Though interest rate rose slightly, it has no impact over the debt financing. Arbitrager from USA will buy more Netherlands currency to sell it to another country. It would result huge amount of gain will be occurred and consequently the reserve for Netherlands pound will fall against dollar and EURO. In accordance with interest-rate-parity theorem, if interest rates are lower domestically, the foreign currency will be selling at a discount in the forward market. As a result, overall debt financing will take a new shape.
The Level of Short-Term and Long-Term Interest Rates and Its Differences
Money market holds short-term instruments with short-term interest and short-term liquidity. Capital market holds long-term instruments with long-term interest and long-term liquidity. Risk is low in money market and high in capital market. Changes in bank rate affect both the market. Bank rate is determined through demand and supply of funds. This has explained below:
In market ‘A’ when interest rate falls, money inflow declines and vice versa. If investors assume that interest will fall in near future again, they may shift their funds to Market B where return is 6% with higher liquidity. As, more funds is shifting to Market B, central bank may raise the bank rate to stabilise money supply in Market A and again funds will shift. Thus, interest rate affects the short-term and long-term interest rates and overall debt financing.
If we assume investors are rational, a decrease in interest rates will prompt investors to move money away from the bond market to the equity market in Netherlands. As a result, the debt and equity financing will be changed. The Common money market instruments have included Bankers’ acceptance, commercial paper Certificate of deposit, treasury bills, repurchase agreements, Eurodollar deposit and money market mutual funds. The Capital market’s instruments contained bonds and treasury notes, mortgage, leases, corporate bonds, state and local government bonds as well as preferred and common stocks.
From above approach, it is clear that bank rate cuts will flow the fund towards different sources. As, depositors or investor move their fund to capital market or money market. Mutual funds are corporations that accept money from savers and then use these funds to buy stocks, long term bonds or short term debt instruments. As a result, the corporation debt structure would be changed. If interest rate drops, savers will tend to move their fund to capital market for high liquidity and return. The official bank rate and Netherlands Treasury bill return has smaller positive correlation. It is about.27. Therefore, the changes in Treasury bill return have matched slightly with bank rate.
Relationship Between Interest Rate and Debt Financing
Model Summary.
Model
R
R Square
Adjusted R Square
Std. Error of the Estimate
1
.383(a)
.147
.025
927.48716
The relationship between interest rate and debt financing is positively correlated and in a lower degree. It means though the interest rate is rising the demand for loan is not declining. It is happening because the rising in interest rate is low. The gap is moderately small. It is not affecting the cost of capital of the company. So, the company is not reducing the debt financing. The explanatory variable is 38.3% means no significant variability.
Relationship Between Inflation and Debt Financing
Model Summary.
Model
R
R Square
Adjusted R Square
Std. Error of the Estimate
1
.369(a)
.136
.012
933.55494
The inflation rate is low. It is not affecting the overall loan status. The rising in inflation rate is not significant as the changes rate is low. So the debt financing is changing its pattern. The following graph shows the trend line of inflation rate over the various years.
Relationship Between Interest Rate and Company A’s Gearing Ratio
Model Summary.
Model
R
R Square
Adjusted R Square
Std. Error of the Estimate
1
.248(a)
.062
-.072
53.67435
The relationship between interest rate and company A is positively correlated and is not significant. The company is not bother about the rise in interest rates. The rising rate is not significant. So, the interest rate is not affecting the debt structure. The R means variability. No significant variability is occurring. The graph represents everything:
Relationship Between Interest Rate and Company B’s Gearing Ratio
Model Summary.
Model
R
R Square
Adjusted R Square
Std. Error of the Estimate
1
.236(a)
.056
-.079
31.86348
The R is not quite significant as the gearing ratio variability is not sufficient. Rising in interest rate is only changing the ratio in 23.6% which means the moderate degree of variability. So, investors are not quite concerned. Corporations can use more debt as the cost of capital is changing significantly.
Relationship Between Inflation and Company A’s Gearing Ratio
Model Summary.
Model
R
R Square
Adjusted R Square
Std. Error of the Estimate
1
.385(a)
.149
.027
51.12596
The growth rate in inflation is not quite significant as it shows only 38.5% variability. So, investors are not quite concerned about debt financing and corporation can use debt as consumer price index is comparatively low. Inflation is not affecting the loan structure.
Relationship Between Inflation and Company B’s Gearing Ratio
Model Summary.
Model
R
R Square
Adjusted R Square
Std. Error of the Estimate
1
.474(a)
.225
.114
28.86587
Company B is moderately affected by the inflation. Most probably it is producing frequent consumable goods. As daily large number of units are selling daily, single inflation can raise the product’s cost and sale price.
Bibliography
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Amadeo in the article ‘How the Federal Reserve Controls Inflation’ touches on an important topic: measures that which government takes to ensure a normal rate of inflation. Controlling inflation is an important measure to ensure the population’s welfare, which is the Federal Reserve’s primary goal. Avoiding recession while controlling prices is the optimal strategy for achieving the purpose. Inflation growth can be controlled in several ways: contracting the money supply and managing inflation expectations, controlling open market operations, and the federal funds rate (Amadeo, 2022). Despite the measures taken, the government cannot always keep inflation at the recommended level.
The Main Idea
The article’s author highlights a sensitive socio-economic topic: ways of government containment of inflation while preventing a recession. The main idea of the author of the article is that the state can effectively use non-obvious inflation control strategies more successfully than using traditional methods (Amadeo, 2022). Traditional methods include open market operations, federal funds, and discount rates (Amadeo, 2022). A non-obvious strategy, which the author considers more successful, is the management of inflationary expectations of the population. The author supports this point of view, citing the words of Ben Bernanke, who noted that public expectations could seriously affect the level of inflation (Amadeo, 2022). The fact is that people, expecting prices to rise, make an unjustified number of purchases, stocking up for future use, which causes inflation to rise. However, the article’s author does not disclose precisely how the state controls public expectations.
It is impossible to completely understand public financial strategies without analyzing the success of the pursued policies. The crisis of 2008 became a severe test for the entire world economy (Amadeo, 2022). According to the author of the article, the crisis became the impetus for developing new strategies for controlling the level of inflation (Amadeo, 2022). The main goal was to maintain banks’ solvency to maintain the population’s satisfactory financial condition. Another test was the 2020 pandemic; for some time, the state managed to contain inflation (Amadeo, 2022). However, not all actions were successful, and inflation began to set record levels in the future.
Ways to Control Public Inflation Expectations
Reducing inflation by controlling the inflationary expectations of buyers, investors, and producers is a reasonably new policy for which the evidence base is not very extensive. The study by Coibion et al. mentions that this policy may be effective, but more theoretical evidence needs to be developed (2020). The fact is that consumer expectations do not seem to be a stable value; respectively, it is difficult to control. The researchers propose to use this strategy in combination with techniques that have yet to be developed (Coibion et al., 2020). Further participation of researchers and collection of statistical data in the long term is needed.
Personal Opinion
It seems to me that the article’s author was quite convincing when talking about methods of inflation control. The author is convincing because she uses factual data on the success of public policy. The article presents all the main methods, which gives the reader a complete picture of the control measures. However, the author does not present a large amount of evidence base to justify the policy’s success in controlling inflationary expectations. According to other researchers, this strategy can be successful in the future (Coibion et al., 2020). Therefore, I think that the author is right in her conclusion that these methods can help control inflation.
Conclusion
Thus, Amadeo’s article provides readers with a detailed list of measures that the state uses to control inflation. The article is important to provide an understanding of how the state creates a stable economic environment. Controlling inflationary expectations can reduce price increases by removing panic buying behavior. However, the state does not always successfully use strategies, an example of this is the 2020 crisis. New measures or a combination of approaches are needed to ensure a stable environment.
