GDP is used by economists to measure a nations total product

GDP is used by economists to measure a nation\'s total production, so clearly they don\'t want the calculation of GDP to miss any significant amounts of production that take place. Still, every country, including the U.S., has people who conceal their buying and selling of goods and services from the government; this activity is referred to as the \"underground economy, \" and its existence means that measurement of GDP isn\'t capturing some production that is taking place. Aside from obvious cases of people buying or selling illegal products or services, why else might someone wish to conceal their production from the government? Can you provide an example of such activity?

Solution

1. Monetary policy refers to the use of interest rates to try and influence the economy. An expansionery monetary policy will mean that interest rates decline. This will mean that the demand for domestic funds will fall and this will cause the currency to depreciate. Similarly an increase in interest rates will cause an increase in demand for funds and this will cause an appreciation of the currency. Monetary policy thus is an indicator which way the exchange rates will move in the future.

2. A money supply increase means an expansionery monetary policy. As the LM curve shifts rightwards this will cause an outflow of capital from the economy. This will mean that the Central Bank will have to buy and sell funds until the exchange rate adjusts itself. Eventually due to the impossible Trinity the interest rates will equalize with the world interest rates. This will be in case of fixed exchange rates. Under flexible exchange rates the money supply component is at the control of the Central Bank and so the balance of payment s is fixed at 0. An expansionery monetary policy in such a case will mean capital flows adjust themselves to ensure that the balance of payments is 0.