Chapter 5Chapter 5

MONEY AND INFLATIONMONEY AND INFLATION

Dr. Mohammed AlwosabiDr. Mohammed Alwosabi

DEFINITION OF INFLATIONDEFINITION OF INFLATION • InflationInflation is a process of continuous (persistent) is a process of continuous (persistent)

increase in the price level. Inflation results in a increase in the price level. Inflation results in a decrease of the value of money.decrease of the value of money.

• In the definition of inflation we have to observe In the definition of inflation we have to observe that: that: – Inflation is an increase in the prices of all goods Inflation is an increase in the prices of all goods

and services not only of a particular good or and services not only of a particular good or service. An increase in the price of one good is service. An increase in the price of one good is not inflation. not inflation.

– Inflation is an ongoing process, not a one-time Inflation is an ongoing process, not a one-time jump in the price level.jump in the price level.

• Milton FriedmanMilton Friedman proposed that " proposed that "inflation is always inflation is always and everywhere a monetary phenomenonand everywhere a monetary phenomenon". ".

• The source of inflation is the high growth rate of The source of inflation is the high growth rate of money supply money supply with “too much money chasing too with “too much money chasing too few goods”. few goods”.

• A quick andA quick and simple solution to fighting inflation is simple solution to fighting inflation is reducing the growth rate of the money supply.reducing the growth rate of the money supply.

• The proposition that inflation is the result of a high The proposition that inflation is the result of a high rate of money growth is supported by evidence rate of money growth is supported by evidence from inflationary episodes throughout the world.from inflationary episodes throughout the world.

• The German hyperinflation of the 1921-23 supports The German hyperinflation of the 1921-23 supports the proposition that excessive monetary growth the proposition that excessive monetary growth causes inflation and not the other way around causes inflation and not the other way around since the increase in monetary growth appears to since the increase in monetary growth appears to have been exogenous, the government expands have been exogenous, the government expands the money supply to finance its expenditures.the money supply to finance its expenditures.

• Evidence for Latin American countries over the Evidence for Latin American countries over the ten-year period 1989-1999 indicates that in every ten-year period 1989-1999 indicates that in every case in which a country's inflation rate is case in which a country's inflation rate is extremely high for any sustained period of time, its extremely high for any sustained period of time, its rate of money growth is extremely highrate of money growth is extremely high

INFLATION RATE:INFLATION RATE:• To measure the inflation rate, we calculate the To measure the inflation rate, we calculate the

annual percentage change in the price level.annual percentage change in the price level.

• we measure the price level (P) of a country using we measure the price level (P) of a country using GDP Deflator or CPI.GDP Deflator or CPI.

100P

P -PRate Inflation

year last

year lastyear this

100 Deflator GDP

Deflator GDP - Deflator GDPRate Inflation

year last

year lastyear this

100 CPI

CPI - CPI Rate Inflation

year last

year lastyear this

• These two equations show the connection These two equations show the connection between the inflation rate and the price level. If the between the inflation rate and the price level. If the price level in the current year is higher than that of price level in the current year is higher than that of the last year, the inflation rate will be positive the last year, the inflation rate will be positive meaning higher inflation rate meaning higher inflation rate the lower is the the lower is the value of money.value of money.

VIEWS OF INFLATIONVIEWS OF INFLATION• According to aggregate demand and supply According to aggregate demand and supply

analysis, analysis, inflation is caused by expansionary inflation is caused by expansionary monetary policiesmonetary policies. .

• A continually increasing money supply causes a A continually increasing money supply causes a continual increase in aggregate demand, continual increase in aggregate demand, everything else held constant.everything else held constant.

• Fiscal policy alone cannot produce inflation. There Fiscal policy alone cannot produce inflation. There is a limit on the total amount of possible is a limit on the total amount of possible government expenditure. Decreasing taxes also government expenditure. Decreasing taxes also has a limit. has a limit.

• Negative supply shocks increase the price level, Negative supply shocks increase the price level, but cannot increase the inflation rate. but cannot increase the inflation rate.

• Suppose that the economy is at the natural rate of Suppose that the economy is at the natural rate of output. In the absence of output. In the absence of accommodating policyaccommodating policy and everything else held constant, the net result of and everything else held constant, the net result of a negative supply shock is that the economy a negative supply shock is that the economy returns to full employment at the initial price level.returns to full employment at the initial price level.

SOURCES OF INFLATIONSOURCES OF INFLATION• Inflation usually occurs as a result of Inflation usually occurs as a result of

expansionary monetary policyexpansionary monetary policy. .

(1) Cost-Push Inflation and High Employment (1) Cost-Push Inflation and High Employment TargetsTargets

• Cost-push inflationCost-push inflation arises due to a decrease in arises due to a decrease in supply as a result of the rise in the per-unit cost supply as a result of the rise in the per-unit cost of production. of production.

• The negative supply shocks mainly occur The negative supply shocks mainly occur because of the push by workers to get higher because of the push by workers to get higher wages, the increase in the prices of other factors wages, the increase in the prices of other factors of production, or the increase in the prices of of production, or the increase in the prices of raw materials (e.g. oil price) raw materials (e.g. oil price)

At a given price level, cost-push inflation starts as At a given price level, cost-push inflation starts as the rise in the cost of production, because of an the rise in the cost of production, because of an increase in the money wage rate or an increase in increase in the money wage rate or an increase in the prices of raw material the prices of raw material firms are willing to firms are willing to produce less amount of the output produce less amount of the output SAS SAS decreases decreases SAS shifts leftward SAS shifts leftward an increase in an increase in prices and unemployment and a decrease in RGDP prices and unemployment and a decrease in RGDP stagflation stagflation

A

B

C

D

E

AD1

AD2

AD3

SAS1

SAS2

SAS3

LAS

Y

P

Y0Y1

P0

P1

P2

P3

P4

• Suppose that the last year price level was PSuppose that the last year price level was P00 and and PGDP is YPGDP is Y00, where AD0, SAS, where AD0, SAS00 and LAS intersect at and LAS intersect at point A, the LR FE equilibrium.point A, the LR FE equilibrium.

• If, in the current year, nominal wages or prices of If, in the current year, nominal wages or prices of other factors of production increase other factors of production increase production production cost increases cost increases firms reduce production firms reduce production SAS SAS SAS curve shifts leftward to SAS1 to point B. SAS curve shifts leftward to SAS1 to point B.

• At point B, price level increases to PAt point B, price level increases to P11 and RGDP and RGDP decreases to Ydecreases to Y11 and therefore unemployment and therefore unemployment increases above its natural rate (below FE) increases above its natural rate (below FE)

• If government fiscal and monetary policies remain If government fiscal and monetary policies remain unchanged, the economy would move back to unchanged, the economy would move back to point Apoint A

• However, as a response to the increase in P and However, as a response to the increase in P and unemployment, and a decrease in RGDP, the unemployment, and a decrease in RGDP, the government increases Qm, G or decreases T government increases Qm, G or decreases T AD increases AD increases AD curve starts to shift rightward AD curve starts to shift rightward until it reaches AD1 at point C, where AD1 until it reaches AD1 at point C, where AD1 intersects with SAS1 and LAS. intersects with SAS1 and LAS.

• At point C, the economy is at higher price level At point C, the economy is at higher price level (P2) and RGDP goes back to PGDP (Y0) at full (P2) and RGDP goes back to PGDP (Y0) at full employment employment

• With the new higher price, money wage rate and With the new higher price, money wage rate and prices of other productive resources start to prices of other productive resources start to increase again which leads to increase in the cost increase again which leads to increase in the cost of production of production SAS curve will shift leftward from SAS curve will shift leftward from SAS1 to SAS2 SAS1 to SAS2 stagflation stagflation the process will be the process will be repeated repeated higher price level (inflation) higher price level (inflation)

• This is an ongoing process of rising price level.This is an ongoing process of rising price level.

• Note that a one-time increase in the price of one Note that a one-time increase in the price of one resource without any following change in AD resource without any following change in AD produces stagflation but not inflation.produces stagflation but not inflation.

• The combination of a successful wage push by The combination of a successful wage push by workers and the government's commitment to workers and the government's commitment to high employment leads to cost-push inflation.high employment leads to cost-push inflation.

• Cost-push inflation is a monetary phenomenon Cost-push inflation is a monetary phenomenon because it cannot occur without the monetary because it cannot occur without the monetary authorities pursuing an accommodating policy of authorities pursuing an accommodating policy of a higher rate of money growth.a higher rate of money growth.

• Accommodating policyAccommodating policy (usually monetary policy) (usually monetary policy) occurs when government pursue active, occurs when government pursue active, discretionary policy to eliminate high discretionary policy to eliminate high unemployment that developed after a successful unemployment that developed after a successful wage push by workers.wage push by workers.

• Monetary expansion increases AD repeatedly, and Monetary expansion increases AD repeatedly, and wages continue to adjust upward. This recipe wages continue to adjust upward. This recipe leads to inflationleads to inflation

• In the absence of an accommodating monetary In the absence of an accommodating monetary policy and everything else held constant, a push policy and everything else held constant, a push by workers to get higher wages will cause higher by workers to get higher wages will cause higher unemployment and higher prices, and the net unemployment and higher prices, and the net result of a negative supply shock is that the result of a negative supply shock is that the economy returns to full employment at the initial economy returns to full employment at the initial price level.price level.

(2) Demand-Pull Inflation(2) Demand-Pull Inflation • Demand-pull inflationDemand-pull inflation occurs when policy makers occurs when policy makers

pursue policies that raise AD and shift the pursue policies that raise AD and shift the aggregate demand curve to the rightaggregate demand curve to the right

• Demand-pull inflation is a result of the increase in Demand-pull inflation is a result of the increase in spending faster than the increase in production of spending faster than the increase in production of output. output.

• An increase in aggregate demand is caused An increase in aggregate demand is caused mainly by the increase in Money supply (quantity mainly by the increase in Money supply (quantity of money (Qm)), or the increase in any of C, I, G, or of money (Qm)), or the increase in any of C, I, G, or XX

• Suppose the economy is at LR full employment Suppose the economy is at LR full employment equilibrium point A, where LAS, AD0 and SAS0 equilibrium point A, where LAS, AD0 and SAS0 intersect with each other. At this point, RGDP = intersect with each other. At this point, RGDP = PGDP = Y0 and P = P0.PGDP = Y0 and P = P0.

• Then, because government goal is to achieve high Then, because government goal is to achieve high level of employment (high level of output), level of employment (high level of output), government may increase Qm, or G, or decrease government may increase Qm, or G, or decrease T, which leads to an increase in AD T, which leads to an increase in AD AD curve AD curve shifts rightward from AD0 to AD1 shifts rightward from AD0 to AD1 the new SR the new SR equilibrium is at point B,equilibrium is at point B,

• At B, RGDP is greater than PGDP, price level At B, RGDP is greater than PGDP, price level increases from P0 to P1, increases from P0 to P1, real wage rate has real wage rate has decreased and unemployment falls below its decreased and unemployment falls below its natural rate (above FE) natural rate (above FE) there is a shortage of there is a shortage of labor labor money wage rate starts to increase to money wage rate starts to increase to attract more labor attract more labor SAS starts to decrease SAS starts to decrease SAS SAS curve starts to shift leftward curve starts to shift leftward P starts to increase P starts to increase and RGDP starts to decrease until SAS curve and RGDP starts to decrease until SAS curve shifted to SAS1 where it intersects AD1 and LAS at shifted to SAS1 where it intersects AD1 and LAS at point Cpoint C

A

B

C

D

E

AD1

AD2

AD3

SAS1

SAS2

SAS3LAS

Y

P

Y0 Y1

P0

P1

P2

P3

P4

• At point C, RGDP goes back to its potential LR and At point C, RGDP goes back to its potential LR and FE level (Y0) and the price level increase further to FE level (Y0) and the price level increase further to P2.P2.

• This process is only a one-time rise in P. For This process is only a one-time rise in P. For inflation to proceed, AD must persistently inflation to proceed, AD must persistently increase.increase.

• At this stage two actions may occur At this stage two actions may occur simultaneously: simultaneously: (1) Government wants to achieve a specific target (1) Government wants to achieve a specific target of high employment (and high production) so it of high employment (and high production) so it will increase G, Qm or decrease taxes, and will increase G, Qm or decrease taxes, and (2) Since now the money wage is higher which (2) Since now the money wage is higher which means people can spend more and as a result P is means people can spend more and as a result P is higher (P2), the result is the increase in Qm higher (P2), the result is the increase in Qm

• In either case In either case increase in AD increase in AD AD curve will AD curve will shift from AD1 to AD2 shift from AD1 to AD2 the process will continue the process will continue higher price level (inflation) higher price level (inflation)

• This is an ongoing process of rising price level.This is an ongoing process of rising price level.

• From the discussion above, according to From the discussion above, according to aggregate demand and supply analysis, it is aggregate demand and supply analysis, it is evidenced that high inflation cannot be driven by evidenced that high inflation cannot be driven by fiscal policy alone. High money growth produces fiscal policy alone. High money growth produces high inflation. Inflation is caused by expansionary high inflation. Inflation is caused by expansionary monetary policies.monetary policies.

• Theoretically, one can distinguish a demand-pull Theoretically, one can distinguish a demand-pull inflation from a cost-push inflation by comparing inflation from a cost-push inflation by comparing the unemployment rate with its natural rate level.the unemployment rate with its natural rate level.

(3) Budget Deficit and Inflation(3) Budget Deficit and Inflation• High government budget deficit relative to GDP High government budget deficit relative to GDP

can be a source of sustained inflation only if can be a source of sustained inflation only if

1.1. it is persistent rather than temporary, and it is persistent rather than temporary, and

2.2. if the government finances it by creating if the government finances it by creating money rather than by issuing bonds to the money rather than by issuing bonds to the publicpublic

ACTIVIST / NONACTIVIST POLICY DEBATEACTIVIST / NONACTIVIST POLICY DEBATE

• ActivistActivist is an economist who views the self- is an economist who views the self-correcting mechanism through wage and price correcting mechanism through wage and price adjustment to be very slow and hence sees the need adjustment to be very slow and hence sees the need for the government to pursue active, discretionary for the government to pursue active, discretionary policy to eliminate high unemployment whenever it policy to eliminate high unemployment whenever it develops.develops.

• Activists argue that monetary and fiscal policies Activists argue that monetary and fiscal policies should be deliberately used to smooth out the should be deliberately used to smooth out the business cycle. business cycle.

• They are in favor of economic fine-tuning, which is They are in favor of economic fine-tuning, which is the frequent use of monetary and fiscal policies to the frequent use of monetary and fiscal policies to counteract even small undesirable movements in counteract even small undesirable movements in economic activity.economic activity.

• According to activists, the economy does not According to activists, the economy does not always equilibrate quickly enough at natural real always equilibrate quickly enough at natural real GDP. GDP.

• They believe that activist monetary policy works; it They believe that activist monetary policy works; it is effective at smoothing out the business cycle.is effective at smoothing out the business cycle.

• NonactivistNonactivist is an economist who believes that the is an economist who believes that the performance of the economy would be improved if performance of the economy would be improved if the government avoided active policy to eliminate the government avoided active policy to eliminate unemploymentunemployment

• Nonactivists argue against the use of deliberate Nonactivists argue against the use of deliberate fiscal and monetary policies. fiscal and monetary policies.

• They believe the discretionary policies should be They believe the discretionary policies should be replaced by a stable and permanent monetary and replaced by a stable and permanent monetary and fiscal framework and the rules should be fiscal framework and the rules should be established in place of activist policies.established in place of activist policies.

• According to nonactivists, in modern economies, According to nonactivists, in modern economies, wages and prices are sufficiently flexible to allow wages and prices are sufficiently flexible to allow the economy to equilibrate at reasonable speed at the economy to equilibrate at reasonable speed at natural real GDP. natural real GDP.

• They believe activist monetary policies may not They believe activist monetary policies may not work, and may be more destabilizing rather than work, and may be more destabilizing rather than stabilizing, and are likely to make matters worse stabilizing, and are likely to make matters worse rather than better.rather than better.

• If aggregate output is below the natural rate level, If aggregate output is below the natural rate level, advocates of activist policy would recommend that advocates of activist policy would recommend that the government try to eliminate the high the government try to eliminate the high unemployment by attempting to shift the unemployment by attempting to shift the aggregate demand curve to the right while aggregate demand curve to the right while advocates of nonactivist policy would recommend advocates of nonactivist policy would recommend that the government to do nothing.that the government to do nothing.

• Activists usually view fiscal policy as having a Activists usually view fiscal policy as having a shorter effectiveness lag than monetary policy, but shorter effectiveness lag than monetary policy, but there is substantial uncertainty about how long there is substantial uncertainty about how long this lag is.this lag is.

• According to activist, the wage and price According to activist, the wage and price adjustment process being extremely slow, and a adjustment process being extremely slow, and a nonactivist policy results in a large loss of output nonactivist policy results in a large loss of output

• Nonactivists usually view fiscal policy as having a Nonactivists usually view fiscal policy as having a longer implementation lag than monetary policy, longer implementation lag than monetary policy, but there is substantial uncertainty about how but there is substantial uncertainty about how long this lag is long this lag is

• Nonactivists contend that an activist policy of Nonactivists contend that an activist policy of shifting the aggregate demand curve will be costly shifting the aggregate demand curve will be costly because it produces more volatility in both the because it produces more volatility in both the price level and output price level and output

• There are There are five time lagsfive time lags that prevent an activist that prevent an activist policy from returning aggregate output to full policy from returning aggregate output to full employment instantaneouslyemployment instantaneously

1. The data lag is the time it takes for policymakers to obtain the data that tell them what is happening to the economy,

2. The recognition lag is the time it takes for policymakers to be sure of what the data are signaling about the future course of the economy.

3. The legislative lag represents the time it takes to pass legislation to implement a particular (fiscal) policy

4. The implementation lag is the time it takes for policymakers to change policy instruments once they have decided on a new policy.

5. The effectiveness lag is the time that it takes for an activist policy to actually influence economic activity.

• The existence of lags prevents the instantaneous The existence of lags prevents the instantaneous adjustment of the economy to policies changing adjustment of the economy to policies changing aggregate demand, thereby strengthening the aggregate demand, thereby strengthening the case for nonactivist policy.case for nonactivist policy.

• However, activist respond that even with time lags, However, activist respond that even with time lags, activist policy moves the economy to full activist policy moves the economy to full employment before the economy's self-correcting employment before the economy's self-correcting mechanism wouldmechanism would

EFFECTS OF INFLATIONEFFECTS OF INFLATION• Inflation may be Inflation may be anticipated (expected)anticipated (expected) or or

unanticipated (unexpected)unanticipated (unexpected)• A moderate anticipated (expected) has a small A moderate anticipated (expected) has a small

cost, but a rapid anticipated inflation is costly cost, but a rapid anticipated inflation is costly because it decreases potential GDP and slow because it decreases potential GDP and slow growth.growth.

• Unanticipated (unexpected) inflationUnanticipated (unexpected) inflation has two main has two main consequences in the consequences in the labor marketlabor market. It redistributes . It redistributes income and results in the departure from full income and results in the departure from full employmentemployment

1.1. Higher than anticipated inflation (unexpectedly Higher than anticipated inflation (unexpectedly high) high) lowers the real wage rate lowers the real wage rate employers employers gain at the expense of workers gain at the expense of workers increases the increases the quantity of labor demanded, makes jobs easier quantity of labor demanded, makes jobs easier to find, and lowers the unemployment rate.to find, and lowers the unemployment rate.

2.2. Lower than anticipated inflation (unexpectedly Lower than anticipated inflation (unexpectedly low) low) raises the real wage rate raises the real wage rate workers gain workers gain at the expense of employers at the expense of employers decreases the decreases the quantity of labor demanded, and increases the quantity of labor demanded, and increases the unemployment rate.unemployment rate.

3.3. If workers and employers base their wages on an If workers and employers base their wages on an inflation forecast that turns out to be correct, inflation forecast that turns out to be correct, neither workers nor employers gain or lose from neither workers nor employers gain or lose from the inflation.the inflation.

• Unanticipated inflationUnanticipated inflation has two main has two main consequences in the consequences in the market for financial capitalmarket for financial capital: : it redistributes income and results in too much or it redistributes income and results in too much or too little lending and borrowing.too little lending and borrowing.

1.1. When the inflation rate is higher than anticipated When the inflation rate is higher than anticipated (unexpectedly high) (unexpectedly high) the real interest rate is the real interest rate is lower than anticipated lower than anticipated borrowers gain but borrowers gain but lenders lose lenders lose borrowers want to have borrowed borrowers want to have borrowed more and lenders want to have loaned less.more and lenders want to have loaned less.

2.2. When the inflation rate is lower than anticipated When the inflation rate is lower than anticipated (unexpectedly low) (unexpectedly low) the real interest rate is the real interest rate is higher than anticipated higher than anticipated lenders gain but lenders gain but borrowers lose borrowers lose borrowers want to have borrowers want to have borrowed less and lenders want to have loaned borrowed less and lenders want to have loaned moremore

• We can conclude from the above that Inflation that We can conclude from the above that Inflation that is higher than expected, transfers resources from is higher than expected, transfers resources from workers to employers and from lenders to workers to employers and from lenders to borrowers. borrowers.

• The opposite is trueThe opposite is true

• High levels of unHigh levels of unanticipatedanticipated inflation have other inflation have other negative impacts on economies for a number of negative impacts on economies for a number of reasons. reasons.

1.1. They lead to distortions in the economy and give They lead to distortions in the economy and give confusing price signals to producers. confusing price signals to producers.

2.2. For individuals on fixed incomes, the rise in For individuals on fixed incomes, the rise in prices increases the cost of living, eroding prices increases the cost of living, eroding purchasing power. purchasing power.

3.3. For investors it erodes the value of saving, while For investors it erodes the value of saving, while effectively reducing the real rate of borrowing for effectively reducing the real rate of borrowing for debtors.debtors.

4.4. It makes goods produced in the country more It makes goods produced in the country more expensive relative to goods produced abroad expensive relative to goods produced abroad resulting in a decrease in exports and an increase resulting in a decrease in exports and an increase in imports.in imports.

5.5. People who hold a lot of money loose from People who hold a lot of money loose from inflation because money value becomes less inflation because money value becomes less overtime.overtime.

6.6. Those who own “real” assets such as land, Those who own “real” assets such as land, stocks, etc. gain from inflation because the value stocks, etc. gain from inflation because the value of these assets goes up with inflation.of these assets goes up with inflation.

SNAPSHOT ON THE CURRENT INFLATION IN GCC COUNTRIES (2007- 08)

• The growth rate of money supply in Gulf countries has in some cases exceeded 20 percent. Check the latest rates of inflation in GCC countries.

• With this double digit inflation nominal interest rates are way below the inflation rate which has resulted in negative real rates of interests.

Factors Causing Inflation in GCC StatsFactors Causing Inflation in GCC Stats

1.1. As a result of pegging GCC currencies - except As a result of pegging GCC currencies - except the Kuwaiti dinar- to a weakening dollar there the Kuwaiti dinar- to a weakening dollar there has been an increase in the cost of goods that has been an increase in the cost of goods that are imported from countries whose currencies are imported from countries whose currencies had appreciated against the dollar, like the EU, had appreciated against the dollar, like the EU, Japan and China. Japan and China.

2.2. Rising food prices internationally due to the high Rising food prices internationally due to the high demand for some types of grains such as corn to demand for some types of grains such as corn to use them as bio fuels in addition to the increase use them as bio fuels in addition to the increase in the price of oil, this added to the increase in in the price of oil, this added to the increase in the food prices. the food prices.

3.3. Huge money supply and abundant liquidity, Huge money supply and abundant liquidity, triggered by sharply higher oil revenues, that is triggered by sharply higher oil revenues, that is accompanied by a fixed supply of goods and accompanied by a fixed supply of goods and services.services.

4.4. The rise in demand for real estate,The rise in demand for real estate, which which increases real estate prices in addition to sharp increases real estate prices in addition to sharp increase in the cost of housing due to shortage increase in the cost of housing due to shortage in property supplies such as steel and cement.in property supplies such as steel and cement.

5.5. The dollar peg forces GCC central banks to The dollar peg forces GCC central banks to follow the US Federal Reserve in setting interest follow the US Federal Reserve in setting interest rates. But while the US central bank continues rates. But while the US central bank continues cutting rates to stimulate a sluggish economy, cutting rates to stimulate a sluggish economy, GCC central banks are faced with expanding GCC central banks are faced with expanding economies that were already overheating at the economies that were already overheating at the higher rates. Cutting interest rate just fuel the higher rates. Cutting interest rate just fuel the inflation more.inflation more.

6.6. The increase in wages without controlling goods The increase in wages without controlling goods markets that just increase prices to take markets that just increase prices to take advantage of the wage riseadvantage of the wage rise

Solutions adopted by GCC Solutions adopted by GCC • It is not necessary to adopt all solutions by all It is not necessary to adopt all solutions by all

countries. Different countries adopted different countries. Different countries adopted different solutions solutions

1.1. De-peg GCC Currencies from the tumbling dollar De-peg GCC Currencies from the tumbling dollar and track a currency basket of their main trade and track a currency basket of their main trade partners, including the US dollar, euro, sterling partners, including the US dollar, euro, sterling and yen. The European Union is now the main and yen. The European Union is now the main trading partner of the GCC accounting for 35 per trading partner of the GCC accounting for 35 per cent of their foreign trade, followed by Asian cent of their foreign trade, followed by Asian countries 30 per cent and the US 10 per cent.countries 30 per cent and the US 10 per cent.

2.2. As a recommended basket, GCC states may link As a recommended basket, GCC states may link their currencies with the International Monetary their currencies with the International Monetary Fund's Special Drawing Rights (SDRs), a mixed Fund's Special Drawing Rights (SDRs), a mixed basket of currencies.basket of currencies.

3.3. Revaluation: the link to the dollar should be Revaluation: the link to the dollar should be revisited without necessarily de-pegging the Gulf revisited without necessarily de-pegging the Gulf currencies, currencies,

4.4. Price should be controlled by governments, Price should be controlled by governments, especially of the necessary products.especially of the necessary products.

5.5. Increase in interest rates should be implemented Increase in interest rates should be implemented to reduce money supply and liquidity in the to reduce money supply and liquidity in the hands of public. hands of public.

6.6. Increase the reserve requirement for banks Increase the reserve requirement for banks forcing lenders to keep more customer deposits forcing lenders to keep more customer deposits in their vaults.in their vaults.

7.7. Central banks should engage in open market Central banks should engage in open market operations to decrease the abundant liquidity.operations to decrease the abundant liquidity.

8.8. Create a suitable environment to invest the Create a suitable environment to invest the liquidity surplus in import substitution products. liquidity surplus in import substitution products.

The Current Global Financial CrisesThe Current Global Financial Crises• The current financial crisis hits the world in many The current financial crisis hits the world in many

ways and has its impact on most countries around ways and has its impact on most countries around the world. the world.

• There have been many debates, discussions, There have been many debates, discussions, articles, meetings, interviews, lectures, legislations, articles, meetings, interviews, lectures, legislations, and summits that create a huge amount of literature and summits that create a huge amount of literature on this crisis.on this crisis.

• It is the assignment of every one of you to write an It is the assignment of every one of you to write an at least a 5-page at least a 5-page (with 12 Times New Roman and 1.5 (with 12 Times New Roman and 1.5 space)space) essay about this crisis stating the following:essay about this crisis stating the following:

1. The causes of the crisis

2. The different impacts of the crisis on countries, consumers’ welfare, and business strength

3. The impact of the crisis on Bahrain and other GCC countries

4. The actions that have been taken to reduce the impact of the crisis

5. The solutions to go out of this crisis