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Role Of Financial System

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From an economic growth and prosperity level, we have to look at the role of the financial system. We know that high inflation means higher interest rates, which lead to less purchasing power and more investing (investors like higher interest rates!). However, lower interest rates spark more lending for business growth, home and auto purchases, etc. How has economic policy affected the lending institutions today? If inflation rises how will it affect the economic recovery in the U.S.?

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This solution discusses the role of the financial system in relation to inflation and economic policy. All questions are thoroughly addressed.

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Inflation is really a double-edged sword. As mentioned in the question, investors do like inflation due to the natural effects of inflation. Money is worth more in an inflationary economy, and this is an attractant to investors and businesses. This is why businesses won't generally invest heavily in assets in a period of deflation - because money (and the investment) is worth less, due to the decreased power of money in a state of deflation. Economic policy has had extensive effects on the lending institutions today. We're still in a period where expansionary fiscal policy leads the way. This is largely in response to the recession that we had around 2008. The government has taken many steps to expand the economy, which include increasing government spending and through various tax programs, including tax credits and rebates. The more the taxpayer gets back in his/her pocket from filing federal income taxes, the more money that the taxpayer can put back into the economy. This was the theory several years ago, when the tax stimulus was created. Each taxpayer got a minimum amount ($300 from what I remember), and others got more, ...

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