Money and Banking Essay Example | Topics and Well Written Essays - 1750 words

Money and Banking - Essay ExampleOne of the shortcomings of an economy with a fixed exchange pasture is that mo nettary policy cannot be utilized to stimulate the economy, although an economy with a floating exchange rate like the U.S. can employ monetary policy to stimulate scotch growth.The macroeconomic shock, please rates in the municipal economy fluctuate with respect to outside(prenominal) affair rates. For instance, when there is an expansionary monetary policy, it give suit interest rate to decline in the domestic economy, as a result, domestic investors will have an opportunity to invest in the foreign market that will cause a chapiter account deficit and cause the exchange rate to decrease. The monetary growth causes a raise in domestic income that in turn causes an add in imports and a current account deficit. When the domestic money supply increases in the foreign market because of an increase in imports and net capital outflows, it leads to depreciation of th e domestic currency due to the weak association between supply and get hold of. The decline in the exchange rate will cause domestic capital to be attractive for foreign investors and the domestic economy will start to draw foreign investment as the exchange rate declines until the BOP equals zero that lead to interest rate parity. 1b The BOP factors that affect the supply for domestic currency in the foreign economies are a raise in imports and an increase in capital outflows in search of higher rates of return. These factors lead to a BOP deficit in the domestic economy and are frequently affected by expansionary monetary policy that causes a decrease in the domestic interest rate. 1C Increase in exports and an increase in capital inflows where foreign investors are in search of higher rates of return in the domestic economy are factors that affect the demand for domestic currency in the foreign economies. In addition, if the domestic economy cause an increase of exports, it indi cate that domestic goods are relatively less pricey compared to foreign goods. Consequently, foreigners will demand more domestic currency as they import compared to domestic exports. When, the domestic rate of returns is more in respect to foreign economies, there will be a raise in demand for the domestic currency, as foreign investors will require domestic currency to bribe domestic capital. 2A Based on flexible exchange rates and relatively responsive capital flows, we can establish that any fluctuate in the capital financial account will be greater in magnitude than fluctuate in the capital account. Thus, the EE curve will be matted compared to the LM curve. A fiscal expansion causes IS curve to shifts up and to the right that lead to increase of interest rates and output (y) .The increase in interest rates lead to increase of inflow of KA and a demand for domestic currency in magnitude than the CA deficit affected by increase in revenues that in turn increases imports relat ive to exports. This causes a BOP surplus that causes the exchange rate to appreciate and lead to shift of the EE curve up and to the left. The exchange rate will appreciate to the point where the BOP comes back to equilibrium. When exchange rate appreciates, the rate of return on domestic capital gets little due to diminishing marginal returns, which will reduce the rate of capital inflows to the domestic econ