7BSP0353 Global Economy Assignment: Monetary Policy and Free Trade

This assignment critically evaluates the shifts in monetary policy by central banks, including those of China, the Euro area, Japan, and the USA, towards further easing in 2019. It examines the macroeconomic and microeconomic functions of central banks, highlighting challenges such as managing interest rates, credit growth, and inflation. The essay contrasts economic theories with real-world scenarios, exploring the ineffectiveness of monetary policy during recessions and the challenges faced by emerging economies. Additionally, the assignment discusses the arguments for and against free trade, considering the potential peak and rollback of trade liberalization. It defines trade liberalization, free trade, and mercantilism, providing a detailed analysis of their impact on the global economy. The analysis covers the roles of organizations like WTO and GATT in maintaining free trade and the impact of comparative advantage and specialization. The essay also discusses new trade theories and their implications for technological mobility and knowledge integration. The assignment concludes by analyzing the policy dilemmas faced by central banks and the evolving landscape of international trade.

Running head: ECONOMICS OF TRADE AND MONETARY INSTITUTIONS
ECONOMICS OF TRADE AND MONETARY INSTITUTIONS
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Critically evaluate the shift by many central banks- including those of China, the Euro
area, Japan and the USA- towards further monetary policy easing in 2019
A central bank of any economy performs both macroeconomic and microeconomic
functions to influence the growth and various other factors of an economy. The
macroeconomic function concentrates on stabilising the price level by using several
instruments. This stabilising operation is performed by controlling liquidity movements in the
concerned economy. However, the crucial tool of controlling the money supply is the
adjustment of the rate of interest. Therefore, the central bank uses either contractionary or
expansionary monetary policy to control inflation and liquidity. This is the macroeconomic
function of the central bank, which helps in the adjustment of business expansion,
unemployment and GDP growth. Apart from controlling the market movements and
economic variables, the central bank creates microeconomic influences by supervising the
commercial banks of the country. The borrowing and lending process between a central bank
and a commercial bank helps in the circulation of liquidity in the economy. Today, the central
bank faces several challenges and dilemmas in designing an appropriate policy to boost
economic performance. Therefore, this essay aims at highlighting the major issues that
central banks are facing in the current generation and the real-life contrasts with the economic
theories.
Central banks in the advanced economies face challenges from reducing the long-term
rate of interest, wealth effects, credit movements and foreign exchange rates. Downward
pressure on interest rate is implemented by lowering premiums or by raising inflation
expectations. In the euro area and the UK, there is a prevalence of negative interest rates or
lower bound of interest rates to boost business confidence (imf.org 2019). However, the
credit growth is witnessing a negative trend, which has been targeted by the European banks
and the central bank of England. In contrast to this, the mortgages are recording good growth

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in Japan, the EU and the UK. This has been reflected in the increase in housing prices,
despite the low rates of interest. This scenario is prevalent in the Eurozone and the United
Kingdom.
Apart from this, several economies are facing issues from declining inflation. Falling
inflation implies negative growth in output and a fall in wage rates. These anticipations help
in designing monetary policies (Pfajfar and Žakelj 2018). More specifically, the advanced
economies are facing such challenges as the economy of the United States. Since the
outbreak of the Great Recession of 2007-2008, the United States has been facing several
shocks in its various macroeconomic variables. The Federal Reserve Bank of the United
States has implemented policies such as quantitative easing to reduce interest rates. This is
another form of easing monetary policy. This policy was introduced because of the
ineffectiveness of the monetary policy. Currently, the economy has a stable interest rate at
1.75 to boost business growth and expansion. Moreover, the US was not the only country
facing issues with the recession; the EU and the UK were witnessing shocks as well. Since
then, the European Central Bank (ECB) and the Bank of England follow easing monetary
policy to support business development in the region (Yellen 2017).
Other than the advancing economies, the central bank of the emerging nations is also
facing challenges from several factors. In the current era, the developing nations are
transitioning from a supervised economy into a free-market economy. This limits the
effectiveness of the monetary policies of the central bank. However, the concern still lies in
stabilising inflation. Fiscal policies are ineffective in such a scenario. Thus, the central bank
has to intervene with monetary policy. Emerging economies crave for high growth rates and
good return. Since the fall of the global recession, certain emerging nations are witnessing
large inflows of capital (Ha and Kang 2015). This is because of their short-term lower interest
rate policy. The economies accepting easing policy are experiencing inflows of FDI

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(Boj.or.jp. 2014). This has been witnessed by economies such as Indonesia, Thailand and
India. Despite these positive inward inflows of capital, the volatile and political instability
challenges the central bank from maintaining such an expansionary phase of growth. This
creates a policy dilemma and affects the financial institutions of the country. Apart from this,
emerging or developing nations faces substantial shocks from the fluctuation in exchange
rates (Bhandari and Frankel 2017). The linkages of the domestic business with global bonds
disrupt their growth process. This is because they are exposed to the risks associated with
currency.
Monetary policy is effective depending on the situation of the economy. Monetary
policy is known to increasing consumer demand, investments in business and control
inflation and interest rates. However, this is not always true. This is because it is ineffective
during the recessionary phase, as the Fed was unable to control the global recession in the US
by using monetary policy. The outcomes of the monetary policy implementations require a
long gestation period. Moreover, it is liable to reduce business growth by increasing interest
rates. In such an environment, a business does not find it profitable to operate and prices tend
to rise. Thus, it can limit the growth of the economy. Similarly, China uses an easing policy
to attract investments in the country. The Peoples Bank in China uses easing monetary policy
to enhance economic growth and business improvement. This implies the importance of
reduced interest rates in the Chinese economy.
The concept of macroeconomics implies that there is an opposite linkage between
unemployment and inflation, that is, with a fall in unemployment, there should be an increase
in inflation. Because of this increase in employment, there is an increase in the wages of
labour. This relation is known as the famous Phillips curve. However, the practical life
experiences and records contradict with the Phillips theory. For instance, the 2013 statistics
of the Bank of England suggests that without a tightening monetary policy, the

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unemployment of the UK fell to 5.1 percent with an absence of an increase in inflation. The
inflation in the UK is about 1.3 percent in the last quarter of 2019, corresponding to a 3.8
percent unemployment rate (Tradingeconomics.com. 2020). Therefore, there is no existence
of the Phillips relation. The target of the Bank of England is to maintain an inflation rate of 2
percent by introducing the easing policy (bankofengland.co.uk 2019). However, there is an
absence of an increase in unemployment. Therefore, the UK does not require a tightening
policy to maintain stability.
Similar to this, the Federal Reserve of the United States has introduced forward
guidance to stabilise interest rates and inflation in 2012 (federalreserve.gov 2015). This
policy did reduce the unemployment level from 6.5 percent to 5 percent, but it took long for
the policy to generate this outcome (The Economist. 2016). This is because, in 2015, the
unemployment rate reduced, that is, after three years of policy implementation. This indicates
the uncertainty of monetary policies that creates a dilemma for central banks. Expansionary
monetary policy turns to generate negative outcomes by increasing inflation. This policy
ensures to create employment opportunities but distorts consumers' spending by raising
prices. As a result, there is a decline in demand, which can counter-attack on employment and
GDP growth of the economy.
Therefore, this can be implied that monetary policy can be both fruitful and worse for
an economy. This is because of their gestation period and time-consuming process.
Moreover, they are ineffective in recessionary situations. All these factors create a policy
dilemma for the central bank. The central bank finds designing policy difficult and
challenging during such a situation. Furthermore, economic theories do not always relate to
real-life events. This again limits the predictability of the central bank and challenges their
authority.

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References
bankofengland.co.uk 2019. policy, M., December..., B., 2019, B., November..., B., 2019, B.,
2020, M., 2020, M., September..., B. and 2019, B. (2019). Monetary policy. [online]
Bankofengland.co.uk. Available at: https://www.bankofengland.co.uk/monetary-policy
[Accessed 16 Jan. 2020].
Bhandari, P. and Frankel, J., 2017. Nominal GDP targeting for developing
countries. Research in Economics, 71(3), pp.491-506.
Boj.or.jp. 2014. [online] Available at:
https://www.boj.or.jp/en/announcements/press/koen_2014/data/ko140109a1.pdf [Accessed
16 Jan. 2020].
federalreserve.gov 2015. Board of Governors of the Federal Reserve System. (2020). The
Fed - What is forward guidance, and how is it used in the Federal Reserve's monetary
policy?. [online] Available at: https://www.federalreserve.gov/faqs/what-is-forward-
guidance-how-is-it-used-in-the-federal-reserve-monetary-policy.htm [Accessed 16 Jan.
2020].
Ha, E. and Kang, M.K., 2015. Government policy responses to financial crises: Identifying
patterns and policy origins in developing countries. World Development, 68, pp.264-281.
imf.org 2019. Monetary Policy and Central Banking. [online] Available at:
https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/20/Monetary-Policy-and-
Central-Banking [Accessed 16 Jan. 2020].
Pfajfar, D. and Žakelj, B., 2018. Inflation expectations and monetary policy design: Evidence
from the laboratory. Macroeconomic Dynamics, 22(4), pp.1035-1075.

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The Economist. 2016. The central bankers’ dilemma. [online] Available at:
https://www.economist.com/buttonwoods-notebook/2016/03/24/the-central-bankers-dilemma
[Accessed 16 Jan. 2020].
Tradingeconomics.com. 2020. The United Kingdom - Economic Indicators. [online]
Available at: https://tradingeconomics.com/united-kingdom/indicators [Accessed 16 Jan.
2020].
Yellen, J.L., 2017. Inflation, uncertainty, and monetary policy. Business Economics, 52(4),
pp.194-207.

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Discuss the arguments for and against free trade in the light of evidence that trade
liberalisation may have peaked and may now be rolled back
The liberalisation of trade has emerged since the inception and inauguration of
globalisation. Trade liberalisation implies the elimination of barriers or restrictions from the
free flow of goods and services between countries. This liberalisation of international trade
indicates there is an absence of trade barriers, which includes tariff, quotas, embargoes and
many others (Gnangnon 2017). This enhances the wealth of the countries and maintains the
sustainability of their development process. Free trade is inaugurated and maintained by
WTO and GATT. These two organisation ensures the limitation of trade barriers and
enhancement of world trade and business (Bhagwati 2017).
Mercantilism is known by the term “commercialism.” The system of mercantilism is
an economic theory that implies that several nations trade with one another to generate
greater revenue and wealth. Under this theory, the government of a nation design policies to
increase export activities more than import activities. This policy helps in maintaining a
positive balance of trade and greater revenue. However, there are several restrictions imposed
on imports to lower the volume of the inflow of currency. Several economists are of the view
that mercantilism is a traditional theory that ultimately leads to trade distortions (Magnusson
2019). This is because whenever a country imposes trade restriction over imports of one
country, the other party retaliates with another range of tariff or trade-restrictive policies.
However, certain economies initially benefited from using the mercantilist system. These
economies consist of Britain during its colonial rule. Britain transferred large volumes of
precious metals from its colonial countries to increase its wealth and strength.
Similar to the liberalisation, the term “free trade” implies the absence of restriction to
trade. Under this theory, there is an absence of trade restrictions over exports and imports of a

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country. Several economies form trade agreements to ensure the free movement of goods and
services between nations. The North American Free Trade Agreement (NAFTA) is a free
trade document signed between the United States, Canada and Mexico to ensure free
movement of commodities and services (Ciuriak et al. 2017).
The traditional theory of free trade or the classical theory enhances the theory of
comparative advantage and specialisation. These two phenomenon states that one country
should specialise in the production of a commodity in which it has a greater comparative
advantage, that is, a low rate of opportunity cost in production. Additionally, the theory infers
that this comparative advantage country should only sell the specialised product (Voinescu
and Moisoiu 2015). The classical theory does not take into account the aspect of the distance
between economies or the concept of knowledge spillovers.
In contrast to this, new trade theories indicate that economies should allow free trade
to enhance technological mobility and knowledge integration. This spillover supports
economies to produce commodities with low comparative advantage. Moreover, new trade
theory includes the concept of distance between nations and the intervention of government.
Both these aspects are absent in the classical theory of free trade. According to the new trade
theory, neighbouring countries trade more than countries with greater distance, irrespective of
the comparative advantage theory (Ranjan and Raychaudhuri 2016). Classical theory misses
the point of government intervention and indicates the free mobility of goods and capital
between nations. Whereas, new trade theory includes the consequences of government
supervision that can affect free trade.
The theory of free international trade helps in international specialisation, which in
turn helps different countries to produce a wide variety of commodities. This reflects the
classical view of comparative advantage; for example, certain economies have no prospects

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or scope of producing certain commodities; this includes Nepal with no oil and Iceland with
no coal. Thus, international trade helps these economies to consume goods, which these
countries are unable to produce. Moreover, international trade increases world consumption
and production. People can consume a wide range of commodities and services (Bayne
2017). Apart from increasing consumer welfare, free trade help in maintain efficiency in the
market. The opening up of the market increases the world competitiveness of industries. As a
result, there is an increase in productivity, absence of monopoly and stabilise prices for
consumers (Solís and Katada 2015). Apart from all these, free trade enhances global relations
among nations and deduces the advent of terrorism or war between economies (Madeira
2016). This absence of barriers helps in uplifting world welfare. In addition to this, higher
efficiency leads to the optimal utilisation of resources. To increase sales and revenue in a
competitive environment, organisations utilise available resources in the best possible way.
Despite all the merits and theoretical evidence, the reality of free trade turns out to be
different. Whenever an economy opens up trade, consumers are open to different prices and
products. The tendency of a consumer to choose cheaper products leads to lower demand for
expensive domestic products. Thus, the domestic producers are worse off due to free trade.
This loss leads to the formation of a war between economies. For instance, the trade war
between the United States and China has emerged due to the greater dependence of US
consumers over the cheap products of China. Apart from this, the trade conflict between
Canada and the US over soft lumber wood is another example of distortions caused due to
free trade. The administration of the United States has imposed trade barriers over these
economies because of the continuous fall in the revenue of the domestic producers and
agriculture sector (Glauber 2018). The movement of Brexit is another example of a
disadvantage of free trade. The UK is a member of the European Union; thus, the UK needs
to follow the policies designed by the European Court and Central Bank. These binding

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policies have distorted the environment, labour market and independence of the United
Kingdom. These restrictions have led to the formation of Brexit.
Free trade distorts the growth and establishment of start-ups. This is because
emerging organisations cannot withstand the dominant force of world competition. These
organisations or infant industries require the support of the government to improve their
status in the global environment. Other than the growing industries, several domestic firms
are readily attacked by the concept of free trade. More specifically, the developing countries
are the major sufferers of these extensive shocks from increasing imports. Emerging
economies continuously faces threats from trade deficits because their imports always exceed
their volume of exports (Bhagwati 2017). As a result, countries tend to impose protectionist
policies to limit the import of goods and services. This includes the imposition of quotas,
tariffs, embargoes and other forms of trade restrictions (Madeira 2016). The government
imposes trade restrictions to support infant industries and domestic producers. Agricultural
sectors also face a substantial magnitude of shocks from free trade movements. The farmers
generate losses from production and imports of commodities. Therefore, the government
introduces subsidies for farmers to ensure their minimum profitability and stabilise
agricultural productivity.
The imposition of trade barriers and constant retaliation leads to disruptions in
international free trade movements. The United States has imposed a 50 percent tariff over
Turkey to limit imports of mineral ore and steel. This is done to protect domestic
manufacturers and extractors of minerals. Together with this, the trade war of US-China,
conflict of US and Canada and the movement of Brexit indicate the elimination of free trade
practices. All these conflicts and war has created friction among certain large economies and
has limited the growth of international free trade. Several economies that are linked with
China and the US are affected by this war. Japan is one of the principal examples of such