Question

6. International Money Markets

a) Why interest rates are different between different countries. Discuss all the relevant factors with giving examples from current interest rates.

b) How can individual countries achieve and maintain lower interest rates. Provide specific policy examples.

c) What are the positive and negative effects of FED’s zero interest rate policy. How do you think this has affected dollar during 2020 amid Covid-19 pandemic?

Answer 1

Hi,

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Question:

a). Answer:

a) Why interest rates are different between different countries. Discuss all the relevant factors with giving examples from current interest rates.

there are different types of economies in the world. Some countries are developed, some countries are developing some countries are poor. There are different economic philosophy has adopted by the countries globally. Some countries have adopted capitalism, some countries have socialism, some countries have socio-capitalism. So, every country has own economic, social and political issue. Some countries are growing fast, some countries are growing slow or very slow, some countries are facing the problem of negative economic growth rate. The major economic, political factors and social factors that affect the interest rate are following as- GDP growth rate, inflation, fiscal deficit, exchange rate, stock market condition, political stability, political system, social stability, social culture etc.

Example:

During the 2008-09,2020 crisis the interest rate of the US touched zero but the interest rate in India is more than 5%. The GDP has shrunk drastically or worst in both the economy (33.4% in the USA and -24% in India) buy the USA is facing deflation and India is facing inflation ( 0.3% in the USA and 6.5% in India). The USA is a developed countries and India is a developing country. India's fiscal deficit expected to touch 7% of GDP in 2020-21 that is comparatively worst against the US. The India currency is more volatile and depreciated rapidly other side the USD is more strong and stable. The higher interest rate will help India to attract more foreign capital/investment and help in appreciating INR. Other side low interest rate will help to the USA to increasing AD that will increase output and price level.

b). Answer:

b) How can individual countries achieve and maintain lower interest rates. Provide specific policy examples.

The  individual countries achieve and maintain lower interest rates through maintaining the high economic growth, low fiscal deficit or budget surplus, maintaining inflation, exchange rate and external borrowing. When the economy will grow rapidly then the it will help to the government to decrease fiscal deficit that will help in decreasing external borrowing. When government borrowing more its increase demand for money and increase interest rate. Other side the government should focus on supply side and maintain a balance between demand and supply that will help in maintaining a low and stable inflation in the economy. When the economy will grow then the stock market will also grow and bullish trends in the stock markets prompt companies to go in for the equity expansion route. This reduces the demand for funds through borrowing. Government should focus on export industry that will help in increasing net export and AD. Increasing net export means strong CA and BOP. The government should adopt a right fiscal policy and drive spending and revenue (tax collection) generation smartly to maintain the fiscal deficit.

Example:
Suppose the economy is facing a cost-push inflation due to high commodities prices. So, the central bank increase interest rate (contractionary monetary policy) and other side increasing interest rate and commodity pice negatively affect AD and economic growth falling down. During this period demand fall rapidly and the economy get into recession. Decreasing demand decrease price level and other side the global recession decreased commodities price. So, to boost the economic growth now the central bank decrease interest rate and stabilized economy. You can see the same problem during the several US recession.

c). Answer:

c) What are the positive and negative effects of FED’s zero interest rate policy. How do you think this has affected dollar during 2020 amid COVID-19 pandemic?

During the COVID-19 crisis the economy shrunk rapidly and the economy is facing deflation. The major issue of this crisis is decreasing AD. The decreasing interest rate (FED’s zero interest rate) increase AD and its increase output and price level. Other side FED’s zero interest rate will increase money supply in the economy and it can increasing inflation in long-run. Other side low interest rates can also raise asset prices. Zero percent interest punishes savers and people on fixed incomes. T low interest rate people refinance its debt (floating interest rate) and in long-run when interest rate increase borrower stuck in a trap.

When interest rate get zero or at lower arte its negatively affect the capital inflow that decrease demand for domestic currency (USD in this case) that negatively affect the exchange rate and currency get depreciated. Yes FED’s zero interest rate affect the exchange rate. When you go through the historical data you see how the Euro/USD has change. USD depreciated against the Euro. After the Feb-2020 USD got fluctuated more and depreciated.

Thank You