Question

1. capital controls have two opposing macroeconomic effects, List the two opposing effects, the factors that cause the effects and describe briefly how the factors cause these opposing effects.

Answer 1

Whenever, the total money in circulation is high in any country, the government undertakes capital control measures which are used to control the inflation levels in any economy. This is done through the use of both the government as well as the Federal Reserve system which is the bankers bank and controls the supply of money directly.

Whenever, there is inflation in the economy, the Federal Bank and the Government take steps to ensure equilibrium in the market. It does so, by increasing the tax rates, and charging higher interest rates from banks which in turn makes taking loans expensive. The end result is that the level of cash or capital in circulation begins to fall rapidly.

The dual effect of this is that even though the inflation comes in check, the government and the Federal Banks risk low growth in the economy which may cause further problems such as unemployment in the economy. The core interest of these measures is to reduce the aggregate demand which is the total demand for goods and services in the country.

When a government reduces the flow of money in any economy, it is indeed seeing a situation wherein the total demand in the country would fall rapidly. However, if this fall is too much, rather than controlling the rising inflation levels, it would lead to a situation of low demand and low supply thereby causing a bigger issue of low growth rates in the country which may dampen the situation even further.

The factors that cause this effect is the increase in interest rates, and taxes which lead to low investment which help controlling inflation on one hand, and on the other limit the growth in the country.

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