Suppose the domestic central bank maintains a fixed exchange rate and free capital mobility. Assume that...

Suppose the domestic central bank maintains a fixed exchange rate and free capital mobility. Assume that the foreign central bank does not change its monetary policy, but the domestic central bank expands credits to the domestic government. What kind of the central bank’s interventions in the foreign exchange market are necessary? Explain also their impacts on the central bank’s balance sheet. Are these impacts the same as those of open market operations? Explain your reasoning.

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Expert Solution

Foreign markets also need to be expansionary by allowing cuts in interest rates, CRR and SLR and easing banking regulations to promote more credit availability and attract investors and loans to get globally competitive and achieve higher growth and real GDP.

The central bank thus now will have shrunked balanced sheet or leveraged as credit is higher and inflow is lower. Impact is different from OMO as bond buying programmes are costlier and out sizable pressure on foreign banks balance sheets.

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Rahul Sunny answered 1 year ago

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