Question

In a monetary model with floating exchange rates, what will happen to exchange rate, if the Central Bank of Turkey has decided to increase money supply? Discuss.

Answer 1

When the bank of Turkey increases the money supply it will cause the depreciation of the Turkish currency because when the money supply increases it will decrease the interest rate in the economy and, at the same time, it will also increase the price level in the economy. So there are two channels through which there will be the depreciation of the Turkish currency. First as the inflation has increased in the Turkey, therefore, Turkish exports will fall and people will demand Goods from other countries which will lead to fall in the value of the Turkish currency in the international market. Secondly, as the interest rate has decreased due to the increase in the money supply people will outflow their money from the Turkish economy and save somewhere else where they will get the higher interest rate on their money, therefore, they will demand foreign currency which will lead to depreciation of the Turkish currency.