Monetary policy is a regulatory policy by which the central bank or monetary authority of a country controls the supply of money, availability of bank credit and cost of money, that is, the rate of Interest.
Monetary policy / monetary management is regarded as an important tool of economic management in India. RBI controls the supply of money and bank credit. The Central bank has the duty to see that legitimate credit requirements are met and at the same credit is not used for unproductive and speculative purposes. RBI rightly calls its credit policy as one of controlled expansion.
Contractionary Monetary Policies and Expansionary Monetary Policies involve changing the amount of the money supply in a country. Expansionary Monetary Policy is simply a policy which expands the supply of money, whereas Contractionary Monetary Policy contracts the supply of a country's currency.
EXPANSIONARY MONETARY POLICY
In the United States, when the Federal Open Market Committee wishes to amplify the money supply, it can do a amalgamation of three things:
1. Purchase securities on the open market, known as Open Market Operations
2. Lower the Federal Discount Rate
3. Lower Reserve Requirements
The interest rate is affected directly by these factors. When the Federal Bank buys securities on the open market, it causes the price of those securities to increase. The Federal Discount Rate is an interest rate, so lowering it is essentially lowering interest rates. If the Federal Bank instead decides to lower reserve requirements, this will cause Banks to have an increase in the amount of money they can invest. This causes the price of investments such as bonds to rise, so interest rates must fall. No matter what tool the Fed uses to expand the money s...
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...lly and fewer domestic goods sold abroad, the balance of trade falls. As well, higher interest rates cause the cost of financing capital projects to be more, so capital investment will be less.
Therefore, Contractionary Monetary Policy:
1. Contractionary monetary policy causes a fall in bond prices and a rise in interest rates.
2. Increased interest rates lead to inferior levels of capital investment.
3. The higher interest rates make domestic bonds more attractive, so the demand for domestic bonds rises and the demand for foreign bonds decreases.
4. The demand for domestic currency increases and the demand for foreign currency decreases, causing a rise in the exchange rate. (The value of the domestic currency is now higher relative to foreign currencies)
5. A higher exchange rate causes exports to decrease, imports to increase and the balance of trade to decrease.
Monetary Policy is another policy used in Keynesianism which is a list of protocols designed to regulate the economy by setting the amount of money that is in circulation and controlled interest levels. The Federal Reserve system, also known as the central banking system in the U.S., which holds control of this policy. Monetary policy has three tools used by the Federal Reserve to enforce this policy. Reserve Requirement is the first tool that determines the lowest amount of money a bank must possess and is not able to lend out. The second way to enforce monetary policy is by using the discount rate or the interest rate a bank will charge.
Open market operations are performed under the direction of the Federal Open Market Committee (FOMC) and is the trading of securities with primary dealers. The discount rate is the interest rate that the Federal Reserve sets for lending to other banks, and the reserve requirement is the minimum amount of money a bank must have in the vault for deposit withdrawls. Of these three tools, the Federal Reserve primarily used the open market operations because it is the most flexible monetary policy tool and it allows the FED to influence the federal funds rate, which is the rate that banks borrow from each other. Open market operations are the quickest, most effective way to influence the economy. A simple breakdows is this; the FED buys securities from banks which injects money into the banks allowing them to loan more out. The injection of money lowers the interest rates, making it easier to obtain credit which increases spending and the economic activity grows. On the reverse, if the FED sells the securities back to the banks, I takes the money out of the system which raises interest rates, reducing economic activity. The direct discount rate often followed by other interest rates, therefore, if drastic changes to the direct discount rate were made, it would mean that interest rates would follow, which could negatively
It may also need to increase its reserves by selling bonds, which would also lower the money supply (Brue, 2004, p. 274). Finally, the last tool the Fed can use is to adjust the discount rate. The discount rate is the interest rate at which the Federal Reserve charges commercial banks for a loan (Brue, 2004, p. 274).
So when the dollar is depreciating, the exchange rate becomes smaller. Exchange rate (foreign exchange rate, forex rate or FX rate) is the number of units of a given currency that can be purchased for one unit of another currency. The United States capital markets are becoming more attractive to foreign investors. Since the dollar is falling, it makes foreigner’s investment in the United States more affordable. Therefore, foreigners take this opportunity to invest in the United States.
Foreign exchange is a commodity, and its price fluctuates based on supply and demand, like any commodity. This is not the place for a complete discussion of supply and demand as relates to foreign exchange, but for our purposes, we will assume that supply of and demand for a country’s currency moves along with the supply of or demand for that country’s products or the products of its trading partners. For example, if one country buys many more goods from its neighbor than its neighbor buys from it, the balance of payments at the end of the year will cause its neighbor’s currency to be in great demand, thereby driving its price up.
Monetary Policy involves using interest rates or changes to money supply to influence the levels of consumer spending and Aggregate Demand.
To put it simply, the exchange rate is a price. As with any other market, price is determined by supply and demand. Whenever they are not equivalent, the exchange rate would change. However, the reality comes to be far more complicated.
...gional Federal Reserve Bank. Monetary policy regarding open market operations is established by the FOMC. Policy regarding reserve requirements and the discount rate is determined by the Federal Reserve Bank. Another role in which the Federal Reserve plays a major part is in the supervision and regulation of the U.S. banking system. The examination of institutions for safety and solidity - banking supervision - is shared with the Office of the Comptroller of the Currency, which supervises national banks, and the Federal Deposit Insurance Corporation, which supervises state banks that are not members of the Federal Reserve System. The implementation of the Federal Reserve in 1913 was truly a great assett to financial and American well being. Without the Federal Reserve, we would have no agency to control monetary policy and push the economy towards full employement.
This is a monetary policy which involves the government’s intervention to curb disorderly trends in the foreign currencies level. In case the quantity of a local currency goes down, the central bank uses the foreign currencies to buy its currency from the foreign economies. This ensures that the economy has ample home currency and thus enough money in circulation.
The first major aspect of the monetary policy by the Federal Reserve is its interest rate policy. This interest rate policy is mainly determined by the figure for the federal funds rate, which is the rate at which commercial banks with balances held within the Federal Reserve can borrow from each other overnight in ord...
In the study of macroeconomics there are several sub factors that affect the economy either favorably or adversely. One dynamic of macroeconomics is monetary policy. Monetary policy consists of deliberate changes in the money supply to influence interest rates and thus the level of spending in the economy. “The goal of a monetary policy is to achieve and maintain price level stability, full employment and economic growth.” (McConnell & Brue, 2004).
In addition, value of exchange rate will affect the cost of imports and exports. MNCs involved in many import and export activities, volatility of exchange rate will bring the positive or negative effects to the firms. In the exchange rate, the relationship of currency between the countries is opposite. For example, domestic currency appreciation causes the import cheaper. On the other hand, foreign currency appreciation causes the import expensive.
According to federalreserveeducation.org, the term "monetary policy" refers to what the Federal Reserve, the nation 's central bank, does to influence the amount of money and credit in the U.S. economy, (n d). The tools used are diverse but the main ones are:
Currency changes have a direct impact on the trade of a country, or export and import. In general, a weaker currency will encourage exports caused imports become expensive, thus reducing the trade deficit of the country for a certain period. The fall of the domestic currency is a major reasons why the export business to remain competitive in the international market and vice versa. Moreover, the low value of the currency has been an opportunity for Malaysia to compete in the export market for Malaysia product becomes more cheaper than a stable value its currency. The government had prepared a number of actions to ensure increased earnings from exports thus ensuring Malaysia Currently Account Balance is always
The foreign exchange markets allow the conversion of currencies, where it helps the firms to conduct trade more efficiently across the national boundaries. In addition, firms can shop for low cost financing in capital markets all over the world and then use the foreign exchange market to convert the foreign currency that they got into whatever currency they require. With the foreign exchange nowadays, anyone can go to other country by converting their domestic currency into the foreign currency. The foreign exchange will follow the rate of exchange according to the country's rate. But still, the foreign exchange market is actually dealing with fluctuation where sometimes it has upward and downward movement.