Monetary Policy Exchange Rates

Implications of a large country engaging in loose monetary policy for exchange rates The report takes into consideration the different cases of monetary policies in some of the nations of the world and tries to analyze the policy measures in light of the theories.In any economy, the monetary policy is implemented on the decision of the Central Bank of the country. On the other hand, the Fiscal policy is implemented by the government of the country. While the implementation of the fiscal policy takes place through the adjustment of the government expenditure, taxes, and the subsidies, the monetary policy takes place through the adjustments of the interest rates. The rates of interest are the main policy tools that the central bank uses for the changes in the policy measures. The monetary policy is based on the liquidity preference theory. The people in a particular economy would be adjusting their spending depending on the rate of interest that is prevailing in the markets. When the central bank wants to reduce the liquidity in the economy, it would increase the rate of interests. With the banks paying a higher return on the bonds, people would start parking their money in the banks for the expectation of the higher returns from the bonds. Thus they would spend less in the present period expecting that they would have more money to spend in the later period. This would lead to a cut in the spending. As a result, the aggregate demand in the economy would decrease. Along with the reduction in the production of the domestic firms, the country would also start importing less. As a result, there would be a favorable condition on the trade balance which in turn would bring more foreign currency in the economy. As a result of this, the value of the domestic currency would appreciate.

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