How does monetary policy affect exchange rates?
Answers
#BAL
Monetary policy may be expansionary or contracting.
Expansionary policy refers to various ways and means adopted by a central bank to infuse more money in an economy. Expansionary policy is adopted mainly to cure recession in an economy. Because of expansionary policy supply of money in an economy increases leading to decrease in cost of money i.e. interest rates reduces. Now, because of reduced interest rates, the value of interest yielding securities (debt securities) reduces.
If these securities are held by foreign investors (F.I.I), the real value of such investments reduces. So, in order to safeguard themselves, the foreign investors sell their investments as early as possible. Since securities are sold and proceeds are converted into foreign currency, the demand for foreign currency increases therefore foreign currency appreciates or domestic currency depreciates. Thus, it takes more of domestic currency to buy foreign currency.
Answer:When the government or Federal Reserve uses monetary or fiscal policy to expand the economy, this increases our income and our demand for imports, and ultimately lowers the exchange rate. And vice versa