Benge - Updated September 26, Monetary policy refers to the course of action a central bank or government agency takes to control the money supply and interest rates in the national economy. This means attempting to control interest rates, levels of inflation and employment levels.
The holders of the U.
Note that foreign investors are often getting better rates of return than what might be readily apparent because the value of the domestic currency is falling relative to their own currency. In summary, the income effect of expansionary monetary policy tends to lower the domestic currency exchange rate, weaken the current account and work to improve the financial account.
A restrictive monetary policy tends to cause the opposite due to the income effect. The domestic currency exchange rate increases, the current account improves and the financial account weakens. The effect of monetary policy on the current and financial accounts is not so clear because the price and income effects move in opposite directions.
For example, the price effect of easy money on the current account tends to strengthen it, while the income effect tends to weaken the current account. Since the effects move in opposite directions, it is not immediately clear what the ultimate impact will be.
We should note that investors can buy and sell financial assets such as stocks and bonds more quickly than producers and consumers can sell and buy physical goods. So initially, interest rate substitution effects would be expected to dominate.
An unanticipated increase in the money supply will cause the exchange rate to go down, the financial account to weaken and current account to gain strength.
Over time, the income effect will come into play. A rising GDP will cause both the trade balance and financial account to weaken. Some argue that for an economy with a foreign sector, monetary policy can create cyclical movements that tend to destabilize an economy.
Unanticipated expansionary monetary policy initially causes the trade balance to improve, but as time progresses, it causes the trade balance to become more negative. It initially causes the capital account to weaken due to lower interest rates, but then later tends to improve it.
Empirical evidence indicates that countries with high rates of monetary supply growth experience both inflation and declining currency exchange rates. An important point to consider is the exchange rates of two countries - their relative rates of money supply growth will help determine how the exchange rate changes.
Fiscal policy changes will produce both price substitution and income effects for exchange rates and balance of payments. Suppose government policymakers enact a program of unanticipated fiscal stimulus.
This would be expected to cause the following sequence of events to occur with regard to the price effect: As a result, the capital account will strengthen become more positive or less negative. The increased demand for the domestic currency will cause its exchange rate to increase.
To summarize, the price effect of a stimulative fiscal policy is to raise the value of the domestic currency, strengthen the capital account and weaken the current account. A restrictive fiscal policy would have the opposite effects:CEPR organises a range of events; some oriented at the researcher community, others at the policy commmunity, private sector and civil society.
Monetary Policy Shocks: What Have We Learned and to What End? Lawrence J. Christiano, Martin Eichenbaum, Charles L.
Evans. NBER Working Paper No.
Issued in February NBER Program(s):Economic Fluctuations and Growth, Monetary Economics This paper reviews recent research that grapples with the question: What happens after an exogenous shock to monetary policy?
Some of the material on this web page is based upon work supported by the National Science Foundation under Grants SES, SES, and. Any opinions, findings and conclusions or recomendations expressed in this material are those of the author(s) and .
What we use monetary policy for. Monetary policy affects how much prices are rising – called the rate of inflation. We set monetary policy to achieve the Government’s target of keeping inflation at 2%..
Low and stable inflation is good for the UK’s economy and it is our main monetary policy aim.
Preliminary versions of economic research. Did Consumers Want Less Debt? Consumer Credit Demand Versus Supply in the Wake of the Financial Crisis. The Timing of Monetary Policy Shocks By GIOVANNI OLIVEI AND SILVANA TENREYRO* A vast empirical literature has documented delayed and persistent effects of mon.