The role of monetary policy in managing the exchange rate

This will, of course, depend on the range of credit institutions that exist in the economy and also on the forms of credit controls that are employed by the Central Bank. This being the case all out efforts must be made by the monetary authority to extend the sphere of the monetised sector to make monetary policy a success.

The commercial banks, mainly provide short-term credit requirements of businessmen and traders and are reluctant to provide medium and long-term credit to meet the financial requirements of industry and for manufacturing in general.

Since there is dearth of complementary resources in such economies and the supply curve of goods is generally inelastic, the abnormal increasing effective demand generated by huge government expenditure paves the way for inflation.

Thus for speeding up the process of economic development, the monetary policy should aim at the efficient management of public debt which implies proper timing of the issuing of government bonds, stabilising their prices and minimising the burden of debt.

Besides, the rise in per capita income and increase in population during the development process also increases the demand for money to carry out day-to-day transactions. This is because, relative to the case of complete markets, both the Phillips curve and the loss function include a welfare-relevant measure of cross-country imbalances.

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.

This being the case, the savings of the people cannot be mobilised effectively for economic development and consequently the rate of growth is very slow. But even with a seemingly independent central bank, a central bank whose hands are not tied to the anti-inflation policy might be deemed as not fully credible; in this case there is an advantage to be had by the central bank being in some way bound to follow through on its policy pronouncements, lending it credibility.

Board of Governors of the Federal Reserve System

Many economists argue that inflation targets are currently set too low by many monetary regimes. A central conjecture of Keynesian economics is that the central bank can stimulate aggregate demand in the short run, because a significant number of prices in the economy are fixed in the short run and firms will produce as many goods and services as are demanded in the long run, however, money is neutral, as in the neoclassical model.

But the rate of saving being low, the government has to resort to large scale borrowing and deficit financing to cope with the rising investment. The Bank announces its policy rate settings on fixed announcement dates eight times a year.

Fiscal policy changes will produce both price substitution and income effects for exchange rates and balance of payments.

Effect of Monetary Policy

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. Using these anchors may prove more complicated for certain exchange rate regimes.

In other words, the Bank is equally concerned about inflation rising above or falling below the target.

Monetary Policy

Appropriate Adjustment between Demand for and Supply of Money, 2. A network of cooperative credit societies with apex banks finances by the Central Bank can go a long way in providing the credit needs of the ruralites.

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. This key rate serves as the benchmark that banks and other financial institutions use to set interest rates for consumer loans, mortgages and other forms of lending.

Thus a policy of low interest rates serves as an incentive to investment for economic development.

What is the role of exchange rates?

Similarly the Central Bank and financial corporations to provide finance to business and industry. In such a situation, the monetary policy should be directed to improving the foreign exchange position.

Besides joint loans by commercial banks and state owned financial institutions can greatly help in this direction. Central bank policymakers may fall victim to overconfidence in managing the macroeconomy in terms of timing, magnitude, and even the qualitative impact of interventions.

The increased demand for the domestic currency will cause its exchange rate to increase. A rational agent has clear preferences, models uncertainty via expected values of variables or functions of variables, and always chooses to perform the action with the optimal expected outcome for itself among all feasible actions — they maximize their utility.

Some argue that for an economy with a foreign sector, monetary policy can create cyclical movements that tend to destabilize an economy. Empirical evidence indicates that countries with high rates of monetary supply growth experience both inflation and declining currency exchange rates.Monetary policy, which is headed by the Federal Reserve and involves changing the money supply and credit availability to individuals can also affect the exchange rates.

Similar to fiscal policy, it can affect the exchange rates through three paths: income, prices, and interest rates. Monetary policy in the United States comprises the Federal Reserve's actions and communications to promote maximum employment, stable prices, and moderate long-term interest rates--the three economic goals the Congress has instructed the Federal Reserve to pursue.

The combination of a flexible exchange rate and independent monetary policy led to a high exchange rate and high interest rates relative to the rest of the world during that period, both of which played an important role in.

This paper investigates the role of monetary policy in managing the euro – dollar exchange rate via alternative cointegration tests and impulse response functions. Role of monetary policy in the economic development of a country are as follows: 1.

Role of Monetary Policy in Economic Development of a Country

Appropriate Adjustment between Demand for and Supply of Money, 2. Price Stability, 3. Credit Control, 4. Creation and Expansion of Financial Institutions, 5. Suitable Interest Rate Structure, 6. Debt Management.

1. Monetary policy is the process by which the monetary authority of a country, typically the central bank or currency board, controls either the cost of very short-term borrowing or the monetary base, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency.

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The role of monetary policy in managing the exchange rate
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