Question

The US Federal Reserve Bank (FED) is considering tightening the money supply now. The United States has an open macro-economy including exports and imports, a market for foreign currency (exchange rates are the price in this market), and international capital mobility. If the FED does restrict the money supply, it will affect investment as it would in a closed economy. But now, adjustments in the foreign currency market occur that induce further changes in aggregate Supply and Demand.

Summarize the majority market adjustments to the new monetary policy. First, explain how a change in the money supply affects aggregate demand(and why). Then explain the second level effects on exchange rates, and the market for goods and services (aggregate supply and demand). Use three supply/demand diagrams, one for the money market, one for the goods and services market, and one for the foreign currency market.

Compared to the closed economy we studied earlier in the semester, are the effects of a change in the money supply larger or smaller when the economy is open (Has trade and floating exchange rates)?

Answer 1

Ans.

At the point when domestic inflation looks as though it will transcend the Fed's objective of 2 percent every year, the Fed can raise interest rates. This builds the expense of acquiring for U.S. firms and family units, debilitating them from acquiring to spend. What's more, for firms and family units with drifting rate advances, raising loan costs additionally diminishes the measure of pay they have left subsequent to paying existing banks, which can compel them to reduce spending. Consequently, raising financing costs diminishes spending ("demand") in the economy. Firms react to this by moderating value rises or notwithstanding cutting costs. Inflation in this way falls.

That is the impact of Fed money related approach inside the U.S. However, universally, the story is extraordinary. At the point when the Fed raises interest rates, global speculators see a chance to improve degree of profitability in dollars than different monetary forms, so they purchase dollars and additionally stocks and bonds designated in dollars. This raises the universal cost of dollar-designated resources, including the dollar itself. In this manner, raising interest rates causes the dollar's swapping scale to rise. On the other hand, if the Fed slices interest rates to urge firms and family units to acquire and spend, global speculators endure a fall in their arrival on dollar-named resources, so they surrender them for higher-yielding resources somewhere else. The dollar's swapping scale in this manner falls.