1. Assume that substantial capital flows occur between the United States, Country A, and Country B, in all directions. If interest rates in Country A decline, how could this affect the value of Currency A against the dollar? How might this decline in Country A’s interest rates possibly affect the value of Currency B against the dollar? Interest rates, inflation, and exchange rates are highly correlated; interest rates have been used by Central banks to exert influence over exchange rate and inflation as a fiscal policy, high interest rates attract foreign capital and tries to rise the exchange rate, on the other hand this impact could be mitigated by the high inflation differential between countries (Bergen, 2010, para.
A Report of the Committee on Fuller Capital Account Convertibility accepted that volatility in exchange rate is caused due to flexible exchange rate policy, inflationary pressure and capital inflow. It recogniz... ... middle of paper ... ...porting the hypothesis. The Aloy and Gente Paper (2005) demonstrated that a country’s population structure has an impact on the overall spending, savings, affecting the purchasing power parity and thus the exchange rate. Other principal factors that cause fluctuations in the exchange rate include the central bank’s intervention, supply of foreign exchange reserves, public debt, trading terms and political stability. Renu Kohli (2002) also attempted to check whether specific factors like structural changes in exchange rate regime, loosening of foreign exchange restrictions and trade liberalization in India had an impact on the real exchange rate.
This determines whether the base money that the Fed will release should decrease or increase. As stated in the simulation, the Fed also "tries to use the money supply as a lever to keep the economy on the rails". This is not an easy task for it requires very complicated analysis. Influence on Money Supply There are several factors affecting the money supply: spread between the discount rate and federal funds rate, required reserve ratio and open market operations. It is very important to understand that whenever the "DR charged by Fed is lower than the FFR charge by other banks; banks tend to borrow from the Fed.
This leads to evolution of the argument known as Fiscal Theory of Price Level (FTPL). To capture the nonmonetary aspects of inflation, a number of economists investigate the main political, institutional and economic determinants of inflation across countries and over time. For instance, Aisen and Veiga (2006) conclude that political instability leads to higher inflation. Their study reveals that an additional government crises and a cabinet change which are used as proxy for measuring political instability raise inflation rate by 16.1% and 9.1% respectively. In another study, Aisen and Veiga (2008) extend their work to further analyze the effect of political instability, social polarization and the quality of institutions on inflation volatility.
I. INTRODUCTION Monetary Policy is how the Central Bank influences the path it wants the economy to follow. It does this through the control of money supply using the short term interest rate as the primary instrument to control inflation and economic growth. The objectives of most Central banks is to sustain low unemployment and relatively stable prices however price stability is the main, medium and longer run goal of monetary policy. An expansionary monetary policy is targeted at increasing the money supply through lowering interest rates with the hope of increasing consumption and investment through easing credit; it is used to combat unemployment in periods of recession.
Under a managed float regime, the foreign exchange rate is determined by demand and supply forces in the market but the central bank intervenes when their domestic currency grow too weak or strong. Under unsterilized foreign exchange intervention, the central bank influences the foreign exchange rate by adjusting MB to instigate changes in MS. Increasing MS by buying international reserves induces depreciation of domestic currency whereas decreasing MS by selling international reserves induces appreciation of domestic currency by influencing both nominal domestic interest rate and expectation about future exchange rate. Central banks also engage in a sterilized foreign exchange interventions “when they offset the purchase or sale of international reserves with a domestic sale or purchase. For example, the purchase of $10000 million of international currency by central bank might be sterilized by selling $10000 million worth of domestic government bonds. When engaging in sterilized intervention, there is no net change in MB, therefore long-term effect does not exist on the exchange rate.
Thus, for the USA changes in the exchange rate of dollar anyway bring benefits and advantages.Reduction of leading positions of the USA in world economy is assisted by the international role of dollar which remains the main reserve and settlement means in world monetary system. Foreign currency reserves of the central banks of other countries for 61% consist of dollars, nearly 2/3 calculations in world trade are carried out in dollars; the dollar serves as a measure of value of many important goods (for example: oil) in the world market; in dollars 3/4 international bank crediting is made (Aleksandr Popov). Changes in the exchange rate of dollar involve deep consequences both for the USA, and for other countries. Increase of its course relatively reduces the volume of export revenue in dollars, quite often involves more considerable, than change of an exchange rate, falling of the world prices, especially on raw materials. On the contrary, decrease in a dollar rate serves as the powerful tool promoting growth of the American export and a pushing off... ... middle of paper ... ...n world movement of monetary resources at the heart of internationalization of monetary policy of the USA the international role of dollar which remains the main reserve and settlement currency in world monetary system lies.
15). The Federal Reserve can also influence the ability for commercial banks to lend by manipulating the reserve ratio. The reserve ratio is the amount the Federal Reserve is requiring the banks to keep in their reserve. By increasing or decreasing the reserve ratio, this determines if a bank has more or less money to lend (The Federal Reserve, 2007). In the event that a main bank would have unexpected or immediate needs for additional funds, the Federal Reserve can make short-term loans (McConnell-Brue, 2004, chpt.
The issue concerning money equilibrium affects the internal and external balances of trade (Columbus, 2004). Exchange rate refers to the price of a currency in relation to another. In the floating exchange rate these prices are determined by the foreign market which fluctuates occasionally. The floating exchange rates have a great impact on a country’s economy and this might trigger its stability or instability. There is an automatic adjustment in case a country has a larger payment deficit which leads to continuous currency outflow from the country.
Monetary authorities utilise the short-term interest rate as an instrument for controlling the supply of money and managing liquidity in the banking sector, this refers to monetary policy, which strive to keep inflation stable and to promote economic growth. Monetary policy is conducted by the central banks in many countries and employs the short-term interest rate as the main operational variable. A change in short-interest rate (monetary policy's main instrument) lead to a change in other interest rate such as personal loan interest rate, home loan interest rate, etc. For example, a decision by central bank to cut down short-term interest rate will tend to cause other interest rates to decline and hence, induce economic growth. In contrary, when central bank tightens monetary policy by raising short-term interest rate, banks will typically increase their interest rates by similar or closely related amount.