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 rallying post is that mo pelfary policy cannot be utilized to stimulate the economy, although an economy with a floating exchange step like the U.S. can employ monetary policy to stimulate frugal emergence.The macroeconomic shock, entertain rates in the interior(prenominal) economy fluctuate with respect to contradictory beguile rates. For instance, when there is an expansionary monetary policy, it willing cause interest rate to ancestry in the home(prenominal) economy, as a result, domestic investors will have an opportunity to invest in the contrary market that will cause a cracking account deficit and cause the exchange rate to decrease. The monetary growth causes a raise in domestic income that in turn causes an increase in imports and a occurrent account deficit. When the domestic money supply increases in the contrary market because of an increase in imports and net gravid out flows, it leads to depreciation of the domestic currency due to the weak association between supply and look at. 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 caus e an increase of exports, it prove that domestic goods are relatively less expensive 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 buy 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 ball will be flat 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 th at in turn increases imports relative 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 smaller due to diminishing marginal returns, which will fasten the rate of capital inflows to the domestic econ