Question

Explain monetary and fiscal policy today, what are the ECB, FED and IBC doing at the moment with currency exchage rates? why are they doing it? and how is this affecting trade around the world.

Answer 1

Monetary policy and fiscal policy refer to the two most widely recognized tools used to influence a nation's economic activity. Monetary policy is primarily concerned with the management of interest rates and the total supply of money in circulation and is generally carried out by central banks such as the U.S. Federal Reserve. Fiscal policy is the collective term for the taxing and spending actions of governments. In the United States, the national fiscal policy is determined by the executive and legislative branches of the government.

the aim of most government fiscal policies is to target the total level of spending, the total composition of spending, or both in an economy. The two most widely used means of affecting fiscal policy are changes in government spending policies or in government tax policies.

If a government believes there is not enough business activity in an economy, it can increase the amount of money it spends, often referred to as "stimulus" spending. If there are not enough tax receipts to pay for the spending increases, governments borrow money by issuing debt securities such as government bonds and, in the process, accumulate debt; this is referred to as deficit spending.

The Federal Reserve, also known as the "Fed," has frequently used three different policy tools to influence the economy: opening market operations, changing reserve requirements for banks and setting the discount rate. Open market operations are carried out on a daily basis where the Fed buys and sells U.S. government bonds to either inject money into the economy or pull money out of circulation. By setting the reserve ratio, or the percentage of deposits that banks are required to keep in reserve, the Fed directly influences the amount of money created when banks make loans. The Fed can also target changes in the discount rate (the interest rate it charges on loans it makes to financial institutions), which is intended to impact short-term interest rates accross the economy .

The starting point for both central banks is the market for central bank money (money market), i. e. the market where commercial banks trade their deposits (reserves) held at the Fed and the ECB, respectively, among each other.
These trades do not affect the overall level of the reserves. This can only be changed by the central banks themselves, which do so by using their respective monetary policy instruments to make (net) additional reserves available to the domestic banking sector or to reduce reserves.
The monetary policy instruments available to the Fed and the ECB are not identical. The ECB grants banks (generally short-term) loans, which are secured by collateral. Historically, loans have typically been granted for terms of one week and three months, but other terms were temporarily offered during the financial crisis.
Normally, the total loan amount was distributed among the (interested) banks through a tender process. Each loan transaction causes an inflow of reserves to the banks. The ECB can therefore reduce overall reserves by reducing the overall volume of a tender compared with the preceding operation.
On balance, the banks would then have to pay money back. The ECB has not made use of this opportunity so far, since every refinancing operation since mid October 2008 has provided banks with as much liquidity as they want (full allotment).
In contrast, the Fed's main instrument (permanent open market operations) is the outright purchase or sale of US government bonds (Treasuries) of various maturities. During the different QE programmes, mortgage-backed securities (MBSs) and agency bonds (particularly those of Fannie Mae and Freddy Mac) have also played a more significant role for the Fed. However, the effect on the market for central bank money remains the same: if the Fed buys securities, it credits the purchase price to the relevant banks' accounts with the Fed, thus increasing reserves (and vice versa). The Fed fine tunes the money market through their temporary open market operations, which are short-term securities repurchase transactions (securities purchases/sales with an agreement to re-purchase/sell them in the future, usually referred to as repos).

The ECB only has a direct influence on the money market with its main monetary policy instruments. Its challenge is to keep money market rates low, even if the interest rate trend in the US reverses.