Question

3) explain the effect of expansionary domestic monetary policy in a country with fixed exchange rates. explain the linkages as the money moves through the economy and has its effects on the capital and current accounts as well as on domestic spending. Is the monetary policy enhanced or made weaker by the fixed exchange rate? explain

4) explain the effect of expansionary domestic fiscal policy in a country with fixed exchange rates. explain the linkages as the changes move through the economy and have their effects on the capital and current accounts as well as on domestic spending. Is the fiscal policy enhanced or made weaker by the fixed exchange rate? explain

Answer 1

3) When there is increase in supply of money and interest rates are fallen its means that there is a involvement expansionary monetary policy. It is a policy measure that encourages spending in the economy and economy starts growing again. In this process, the inflation increases and purchasing power of domestic currency comes down. As a result, the exchange rate of the domestic currency w.r.t. the other major currencies in the world, depreciates. Since the domestic currency w.r.t. other major currencies, weakens, then the export from the domestic economy to the rest of the world, increases. It happens due to the low price advantage in the international market. It helps to increase the current account balance. Further, the interest rate is at the lowest level, and then domestic capital also moves out of the country to get better return. It affects negatively to the capital account. So, current account improves, but capital account goes negative.

4) Domestic spending in the form of consumption based spending by the households and investment spending by the firms increases due to the expansionary monetary policy. Further, the flexible exchange rate is driven by the market forces and it is the part of the economic approach to be followed by the government in combination of the central bank of the nation. Here, the flexible exchange rate improves the economic scenario and when the conditions worsen in terms of the depreciation of the domestic currency, and then central bank such as Federal Reserve can stop the expansionary monetary policy or take other contractionary measures to stop the falling value of the domestic currency. Flexible exchange rate is good for the economy as it reflects the true status of the economy.