Question

a. What are those monetary tools and how does the federal reserves or the central banks use its monetary tools in order to influence the economy?

b. What do you think is going to happen to the economy as the results of changes in the currency?

Answer 1

A. Central banks around the world have three major monetary tools with which that influence their economies.

Open Market Operations : Its when central banks buys or sells securities. When central banks buys securities the amount of currency flow in the economy increases making available more funds with the private banks to lend. In the vice versa case when central banks sell securities it reduces the money with private banks thereby reducing funds in the market

Reserve requirement : In this case if central banks orders to increase the reserve requirements of private banks the amount at their disposal decreases decreasing the money in the market and if reserve requirements are relaxed then more money flows in the economy system.

Interest rate : Repo rates and reverse repo rates are the way central banks influence rate of interest in the economy. Repo rate is the rate at which central banks lend money to the private banks and repurchase rate is the exact opposite of it. When repo rates increase or decrease it directly varies the cost of funds in the market.

B. Among other chain reactions the very basic consequence of change in currency flow in the market will be on inflation or deflation status of the economy. When too much money is available in the market, more money follows less goods leading to increase in demand and decrease in supply triggered inflation. If less money there will be deflation. In case there is free market and price of domestic currency decreases that would mean its import will become more expensive and export will become cheaper.