Final Project

Impact of monetary policy on exchange rate Economics Assignment
Topic: Impact of monetary policy on exchange rate
Submitted By: Kartik Bhardwaj Nitu Bharti Mansi gupta Pallavi Mishra
Roll No. 34 Roll No. 59 Roll No.38 Roll No. 60
Submitted To: Prof. Pankaj Upadhya
Impact of monetary policy on exchange rate

ACKNOWLEDEMENT
We would like to express our special thanks of gratitude to our professor Mr. Pankaj Upadhaya who gave us the opportunity to do this wonderful project on the topic Impact of Monetary policy on exchange rate which helped us in doing a lot of research and we came to know about so many new things. We have taken efforts in this project and however, it would not have been possible without the kind support and help of each one of us. We have made this project not only for marks but to also increase our knowledge.

TOPICS Title page Acknowledgement Table of contents Introduction to exchange rate Factors influencing foreign exchange rates PAGE NUMBER 1 2 3 5-12 13-16
Measuring monetary policy shocks in France, Germany, Italy
17 -25
What is monetary policy? Instruments and merits and demerits of monetary policy Countries with monetary policy
26-25 26-31
32-42
How Does Monetary Policy Impact the 43-45 Economy? Monetary Policy and Financial Stability 46-47
Case studyIndian monetary policy and the RBI Lets focus upon inflation Indias experience with capital controls 50-51 48-49
Indias exchange rate policy: weighing the 52-53 trade-offs

Case study on USAs monetary policy 54-55

INTRODUCTION:
EXCHANGE RATE An exchange rate between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one countrys currency in terms of another currency. Also known as the foreign-exchange rate, forex rate or FX rate. TYPES OF EXCHANGE RATE An exchange can operate under one of four main types of exchange rate systems: Fully fixed exchange rates In a fixed exchange rate system, the government (or the central bank acting on its behalf) intervenes in the currency market in order to keep the exchange rate close to a fixed target. It is committed to a single fixed exchange rate and does not allow major fluctuations from this central rate. Semi-fixed exchange rates Currency can move within a permitted range, but the exchange rate is the dominant target of economic policy-making. Interest rates are set to meet the target exchange rate. Free floating The value of the currency is determined solely by supply and demand in the foreign exchange market. Consequently, trade flows and capital flows are the main factors affecting the exchange rate. The definition of a floating exchange rate system is a monetary system in which exchange rates are allowed to move due to market forces without intervention by national governments. The Bank of England, for example, does not actively intervene in the currency markets to achieve a desired exchange rate level. With floating exchange rates, changes in market supply and demand cause a currency to change in value. Pure free floating exchange rates are rare - most governments at one time or another seek to 'manage' the value of their currency through changes in interest rates and other means of controls. Managed floating exchange rates Most governments engage in managed floating systems, if not part of a fixed exchange rate system. The advantages of fixed exchange rates Fixed rates provide greater certainty for exporters and importers and, under normal circumstances, there is less speculative activity - though this depends on whether dealers in foreign exchange markets regard a given fixed exchange rate as appropriate and credible
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The advantages of floating exchange rates Fluctuations in the exchange rate can provide an automatic adjustment for countries with a large balance of payments deficit. A second key advantage of floating exchange rates is that it allows the government/monetary authority flexibility in determining interest rates as they do not need to be used to influence the exchange rate. WHO DETERMINES THE EXCHANGE RATE If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rate for such currencies is likely to change almost constantly as quoted on financial markets, mainly by banks, around the world. A movable or adjustable peg system is a system of fixed exchange rates, but with a provision for the devaluation of a currency. If an American buys a British Rover, there will be an increase in the demand curve for pounds. The demand curve will shift from D1 to D2. In order to buy these pounds the supply of dollars will have to rise. The supply curve in the second diagram shifts to the right from S1 to S2. In the first diagram, the 'price' of the pound rises from 1 = $1.50 to 1 = $1.60. In the second diagram, the 'price' of the dollar falls from $1 = 0.67 to $1 = 0.63. Obviously, if the price of the pound in terms of dollars rises, the price of the dollar in terms of pounds must fall. Note that the prices used above were made up. It is very unlikely that the changes in demand and supply of pounds and dollars will cause the exchange rate to change by so much! From this analysis, it follows that if the value of exports into the USA (from the UK) exceed the value of imports into the UK (from the USA) then the value of the pound in terms of dollars will rise and the value of the dollar in terms of pounds will fall. If the UK imports more than it exports (which is more usual) then the value of the pound will fall. Exchange rates between currencies can be either controlled as in the case of India prior to the reforms or left to the market to decide, as is the case now in India. In the case of controlled exchange rates, it is quite obvious that the government would fix them, so the question really boils down to what is the process by which markets determine rates. The process is really not different in its essentials from the way any market functions. The supply and demand for different goods determine what their prices are. In this case, substitute currencies for goods. Lets take the case of one foreign currency to understand how this market works. Thus, the dollar-rupee exchange rate will depend on how the demand-supply balance moves. When the demand for dollars in India rises and supply does not rise correspondingly, each dollar will cost more rupees to buy.

Determinants of Exchange Rates Numerous factors determine exchange rates, and all are related to the trading relationship between two countries. Remember, exchange rates are relative, and are expressed as a comparison of the currencies of two countries. The following are some of the principal determinants of the exchange rate between two countries. Note that these factors are in no particular order; like many aspects of economics, the relative importance of these factors is subject to much debate. 1. Differentials in Inflation As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies. During the last half of the twentieth century, the countries with low inflation included Japan, Germany and Switzerland, while the U.S. and Canada achieved low inflation only later. Those countries with higher inflation typically see depreciation in their currency in relation to the currencies of their trading partners. This is also usually accompanied by higher interest rates. 2. Differentials in Interest Rates Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest rates, central banks exert influence over both inflation and exchange rates, and changing interest rates impact inflation and currency values. Higher interest rates offer lenders in an economy a higher return relative to other countries. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if inflation in the country is much higher than in others, or if additional factors serve to drive the currency down. The opposite relationship exists for decreasing interest rates - that is, lower interest rates tend to decrease exchange rates. 3. Current-Account Deficits The current account is the balance of trade between a country and its trading partners, reflecting all payments between countries for goods, services, interest and dividends. A deficit in the current account shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital from foreign sources to make up the deficit. In other words, the country requires more foreign currency than it receives through sales of exports, and it supplies more of its own currency than foreigners demand for its products. The excess demand for foreign currency lowers the country's exchange rate until domestic goods and services are cheap enough for foreigners, and foreign assets are too expensive to generate sales for domestic interest. 4. Public Debt Countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity stimulates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors. The reason? A large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future. In the worst case scenario, a government may print money to pay part of a large debt, but increasing the money supply inevitably causes inflation. Moreover, if a government is not
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able to service its deficit through domestic means (selling domestic bonds, increasing the money supply), then it must increase the supply of securities for sale to foreigners, thereby lowering their prices. Finally, a large debt may prove worrisome to foreigners if they believe the country risks defaulting on its obligations. Foreigners will be less willing to own securities denominated in that currency if the risk of default is great. For this reason, the country's debt rating (as determined by Moody's or Standard & Poor's, for example) is a crucial determinant of its exchange rate. 5. Terms of Trade A ratio comparing export prices to import prices, the terms of trade is related to current accounts and the balance of payments. If the price of a country's exports rises by a greater rate than that of its imports, its terms of trade have favourably improved. Increasing terms of trade shows greater demand for the country's exports. This, in turn, results in rising revenues from exports, which provides increased demand for the country's currency (and an increase in the currency's value). If the price of exports rises by a smaller rate than that of its imports, the currency's value will decrease in relation to its trading partners.
6. Political Stability and Economic Performance Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk. Political turmoil, for example, can cause a loss of confidence in a currency and a movement of capital to the currencies of more stable countries.
Currency Board This is a very important aspect of exchange rate regimes as it is the main prime mover for setting up of exchange rates in a particular country. The currency board must see that the central bank adheres to the objectives set by the board. Features of Currency Boards
The first and foremost condition that has to be met by a national currency board is that the reserves of foreign currency which it holds should be enough to convert all notes and coins held by them into at least 110% to 115% of the base value. The board has an absolute control over the convertibility foreign currency in coins and notes at a fixed exchange rate in relation to the domestic rates, and there may be no restriction in the case of current or capital account transactions. The board can earn profit through interest only from foreign currency held by it. The currency board does not have any discretionary power and it cannot lend any money to the government. Likewise, the government cannot print extra money for its expenses and has to acquire this through taxes or borrowing. The board cannot lend money to commercial banks.
Finally, the currency board cannot manipulate interest rates by applying discounts to certain banks. The pegging system is what controls the rates and keeps them closely aligned with the countries concerned. Dollarization It is worthwhile to say a few words about the concept that has come to be known as dollarization. This happens when a foreign currency is used in parallel with the domestic currency. It need not only apply to the use of dollars, but it is most commonly used, hence the word dollarization is used. The stability of the dollar has tempted several countries to adopt it as their official policy. Some of the major countries which adopt this policy are Panama, Ecuador and El Salvador. Dollarization may take place unofficially also, wherein private parties favour foreign currency for their transactions. This is likely to occur in countries where the local currency is weak. Fixed Exchange Rate Maintenance So how does a government maintain a fixed exchange rate? Usually a government achieves this by simply trading its currency on the international market. This explains the need for governments to keep a stock of foreign currency. What usually takes place here is a kind of speculation game by the government. If the exchange rate drops, then the government purchases its own currency and uses it as a reserve. This creates a demand for that particular currency and it increases the price. If the exchange rates rise then the government sells its currency which results in an increase in its foreign reserves. Another method of maintaining exchange rates by governments is by monopolizing the rate by making trading of currency at any other rate illegal. Even though this practice gives rise to a black market, several countries have had considerable success by adopting this system. China is a good example of a country which has managed to maintain a monopoly on its currency rate. Advantages

A fixed exchange rate may minimize instabilities in real economic activity. Central banks can acquire credibility by fixing their country's currency to that of a more disciplined nation. On a microeconomic level, a country with poorly developed or illiquid money markets may fix their exchange rates to provide its residents with a synthetic money market with the liquidity of the markets of the country that provides the vehicle currency A fixed exchange rate reduces volatility and fluctuations in relative prices It eliminates exchange rate risk by reducing the associated uncertainty It imposes discipline on the monetary authority International trade and investment ows between countries are facilitated Speculation in the currency markets is likely to be less destabilizing under a fixed exchange rate system than it is in a flexible one, since it does not amplify fluctuations resulting from business cycles
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Fixed exchange rates impose a price discipline on nations with higher inflation rates than the rest of the world, as such a nation is likely to face persistent deficits in its balance of payments and loss of reserves.
Disadvantages
The need for a fixed exchange rate regime is challenged by the emergence of sophisticated derivatives and financial tools in recent years, which allow rms to hedge exchange rate uctuations The announced exchange rate may not coincide with the market equilibrium exchange rate, thus leading to excess demand or excess supply The central bank needs to hold stocks of both foreign and domestic currencies at all times in order to adjust and maintain exchange rates and absorb the excess demand or supply Fixed exchange rate does not allow for automatic correction of imbalances in the nation's balance of payments since the currency cannot appreciate/depreciate as dictated by the market It fails to identify the degree of comparative advantage or disadvantage of the nation and may lead to inefficient allocation of resources throughout the world There exists the possibility of policy delays and mistakes in achieving external balance The cost of government intervention is imposed upon the foreign exchange market
Capital Control Capital control is the monetary policy of a country to regulate the flow of capital in and out of the country. It is a restriction on free movement of capital. Capital control is basically a device meant to dampen volatility in capital markets. This is mainly intended to control the spikes which may occur in capital markets which can be damaging to the economy on the whole. Capital control may be exercised on inflows or outflows, depending on where the priority lies. According to the IMF, most countries place controls on inflows as a response to the abnormal growth of certain sectors in the country. These controls are placed in areas where the foreign exchange reserves of the country are at risk of getting depleted.
Fixed Exchange Rate Regime vs. Capital Control It is not entirely true that the fixed exchange regime facilitates stability. This system can invite speculative attacks in the economy by unscrupulous traders and the only means of controlling this is through the system of capital control. In this context, we should consider a fixed rate regime as part of capital control. A good example is that of China, where, since 1996, free exchange was permitted in respect to current account transactions. So while both the systems have their advantages and disadvantages, it could be concluded that a balanced combination of both systems is paramount to the healthy economic growth of a country.
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Conclusion It becomes apparent that governments need to exercise some control on money markets if any element of fair play is be maintained. Moreover, historically speaking, the Great Depression of 1929-30 bears witness to the extent of economic damage possible as a consequence of governments neglecting to monitor money markets efficiently. Similarly, the recent recession also demonstrates that money markets cannot be allowed to grow without any checks and balances some control has to be applied if economies are to grow in a healthy way. Managed Floating Rate Systems A managed oating rate systems is a hybrid of a xed exchange rate and a exible exchange rate system. In a country with a managed oating exchange rate system, the central bank becomes a key participant in the foreign exchange market. Unlike in a xed exchange rate regime, the central bank does not have an explicit set value for the currency; however, unlike in a exible exchange rate regime, it doesnt allow the market to freely determine the value of the currency. Instead, the central bank has either an implicit target value or an explicit range of target values for their currency: it intervenes in the foreign exchange market by buying and selling domestic and foreign currency to keep the exchange rate close to this desired implicit value or within the desired target values. Example: Suppose that Thailand had a managed oating rate system and that the Thai Central bank wants to keep the value of the Baht close to 25 Baht/$. In a managed oating Regime, the Thai central bank is willing to tolerate small uctuations in the exchange rate (say from 24.75 to 25.25) without getting involved in the market. If, however, there is excess demand for Baht in the rest of the market causing appreciation below the 24.75 level the Central Bank increases the supply of Baht by selling Baht for dollars and acquiring holdings of U.S dollars. Similarly if there is excess supply of Baht causing depreciation above the 25.25 level, the Central Bank increases the demand for Baht by exchanging dollars for Baht and running down its holdings of U.S dollars. So under a managed oating regime, the central bank holds stocks of foreign currency: these Holdings are known as foreign exchange reserves. It is important to realize that a managed oat can only work when the implicit target is close to the equilibrium rate that would prevail in the absence of central bank intervention. Otherwise, the central bank will deplete its foreign exchange reserves and the country will be in a exible exchange rate system because they cannot longer intervene. Some managed oating regimes use an explicit range of target values instead of using an implicit range of values. For example, in the early 1990s, many European countries participatedin an arrangement called the Exchange Rate Mechanism (ERM) in which they set a rangeof values (a band that was 2.25 percentage points wide on either side of a central value) in which their currencies were free to move in but agreed to intervene to prevent currencies from moving outside that range. Suppose the central rate was 0.5 British pounds/German marks. Then the pound-mark exchange rate would be allowed to uctuate in the range 0.48875 Pounds/DM and 0.51125 Pounds/DM. However, if the pound depreciated and the exchange rate approached
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0.51125Pounds/DM or if the pound appreciated and the exchange rate approached 0.48875 Pounds/DM. Conclusion Managed exchange rate systems permit the government to place some influence on an exchange rate that would otherwise be freely floating. Managed means the exchange rate system has attributes of both systems. On one hand allowing one's currency to be dictated in its entirety by a foreign nation would be undesirable since exogenous shocks from the pegged country would affect your currency. There would be little control of the Central Bank to change expectations or impact the economy through a change in the exchange rate (thus impact interest rates through supply and demand for domestic currency) as the entire exchange system would be dependent on the foreign nation's policies. The central bank will also be in a position to utilize monetary policy to its advantage, or essentially, the changes in monetary policy will have their desired effect on a market where the exchange is not fixed.
SIGNIFICANCE OF EXCHANGE RATES The exchange rate expresses the national currency's quotation in respect to foreign ones. For example, if one US dollar is worth 10 000 Japanese Yen, then the exchange rate of dollar is 10 000 Yen. If something costs 30 000 Yen, it automatically costs 3 US dollars as a matter of accountancy. Going on with factious numbers, a Japan GDP of 8 million Yen would then be worth 800 Dollars. Thus, the exchange rate is a conversion factor, a multiplier or a ratio, depending on the direction of conversion. In a slightly different perspective, the exchange rate is a price. If the exchange rate can freely move, the exchange rate may turn out to be the fastest moving price in the economy, bringing together all the foreign goods with it.
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Factors influencing foreign exchange rates The following theories explain the fluctuations in exchange rates in a floating exchange rate regime (In a fixed exchange rate regime, rates are decided by its government): 1. International parity conditions: Relative Purchasing Power Parity, interest rate parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world. 2. Balance of payments model (see exchange rate): This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current account deficit. 3. Asset market model (see exchange rate): views currencies as an important asset class for constructing investment portfolios. Assets prices are influenced mostly by people's willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies. None of the models developed so far succeed to explain exchange rates and volatility in the longer time frames. For shorter time frames (less than a few days) algorithms can be devised to predict prices. It is understood from the above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of demand and supply. The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distils) as much of what is going on in the world at any given time as foreign exchange. Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology. Economic factors These include: (a) economic policy, disseminated by government agencies and central banks, (b) economic conditions, generally revealed through economic reports, and other economic indicators.
Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates). Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency. Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency
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to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency. Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation. Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be. Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency. Its effects are more prominent if the increase is in the traded sector.
Political conditions Internal, regional, and international political conditions and events can have a profound effect on currency markets. All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political upheaval and instability can have a negative impact on a nation's economy. For example, destabilization of coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may spur positive/negative interest in a neighbouring country and, in the process, affect its currency. Market psychology Market psychology and trader perceptions influence the foreign exchange market in a variety of ways:
Flights to quality: Unsettling international events can lead to a "flight to quality", a type of capital flight whereby investors move their assets to a perceived "safe haven". There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts. The U.S. dollar, Swiss franc and gold have been traditional safe havens during times of political or economic uncertainty. Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends "Buy the rumor, sell the fact": This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought".[18] To buy the rumor or sell the fact can also be an example of the cognitive
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bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices. Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number it becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight. Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns.
IMPLICATION OF EXCHANGE RATE REGIMES Countries with fixed exchange rate are positive but weakly correlated with GDP growth. Their correlation is positive, which means that these two units move in same direction. The national currencies of those countries are stable (no daily fluctuations in the national currency), and therefore, as a result of the security that import-export oriented companies have, the real GDP growth has a significant positive rates. Their correlation is weak, and this means that GDP growth in a small extent depends on the exchange rate. Usually, countries with fixed exchange rates have a low rate of inflation because the fixed rate imposes monetary discipline in one country i.e. restricts the process of money creation. So, the governments of the countries with fixed exchange rates do not increase the money supply, on that way they prevents inflation and thus the depreciation of the currency. They have weak correlation because the inflation does not depend just on the exchange rate. For instance, in 2008 countries with fixed exchange rate reached the highest inflation rate (12% in some countries), due to the increased price of oil and food. The rate of GDP growth in countries with fixed exchange rate is negative correlated with the trade deficit. This means that if the rate of GDP growth increases, the trade deficit declines and vice versa. In conditions of fixed exchange rate, the rate of GDP is negative correlated with the unemployment rate. After we discussed the macroeconomic implications of the fixed exchange rate, we move toward those countries that have adopted fluctuating exchange rate. If we see the relation between the fluctuating exchange rate and the rate of GDP growth we could see that the coefficient of their correlation is negative. This means that these 2 units move inapposite directions i.e. when the exchange rate increases, the rate of GDP growth declinesand vice versa. It must be noted that the countries we took in our analysis are developing countries, thus most of them are imports oriented than export. In other words, when their national currency devalues, the imported costs for certain products or materials are higher, and therefore the companies are not stimulated to produce in their countries.
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The fluctuating exchange rate is weakly and positive correlated with the inflation. The coefficient of correlation is positive. This means that these two units are moving in same direction. If one goes up. the other variable also increases. For example, if exchange rates rise or devalue the national currency, inflation goes in the same direction and that it goes forward. The average inflation of the countries (taken in the analysis) with fluctuating exchange rate is 8,037% which is higher than the inflation rate in countries with fixed rate-4, 53%.In countries with fluctuating rate, the rate of GDP growth is weakly negative correlated with the trade deficit i.e. As GDP increases, the trade deficit decreases. It must be noted that their correlation is stronger in countries with fixed exchange rate. That means that the trade deficit to a greater extent depends on GDP growth in countries with fixed exchange rates than countries with floating exchange rates.
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MEASURING MONETARY POLICY SHOCKS IN FRANCE, GERMANY AND ITALY, THE ROLE OF EXCHANGE RATE: Introduction In the extensive literature on measuring monetary policy shocks using identified vector Auto regressions (VARs), the exchange rate has typically been omitted from the analysis .While the neglect of the exchange rate may be justified for a large, relatively closed economy like the United States, the exchange rate plays a prominent role in more open economies. Indeed, many countries, including those that participate in the exchange rate mechanism (ERM) of the European Monetary System, find it useful to target the exchange rate. In such a regime domestic monetary policy shocks will be mainly reflected in exchange rate innovations. More generally, monetary authorities in open\economies may offset some of the contemporaneous exchange rate shocks they face because these shocks significantly affect the economy, again suggesting a role for the exchange rate in the measurement of the policy stance. This study focuses on the role of the ECU exchange rate in the monetary policy strategy of France, Germany and Italy. Two factors suggest the importance of the ECU exchange rate in these countries. First, France, Germany and Italy are considerably more open than the US economy, in particular with respect to other European countries, and, second, they have participated in the ERM since its inception in March 1979. Originally the ERM was established as a symmetric system in which each participant would peg its exchange rate against the ECU, defined as a basket of EC currencies. De facto, Germany became the anchor country of the system, thereby setting monetary policy for the ERM area as a whole. This asymmetry between Germany and the other ERM countries suggests that the role of the ECU exchange rate in measuring domestic monetary policy innovations may be smaller in Germany than in France and Italy. Including an exchange rate in the VAR analysis complicates the identification problem because there is no obvious contemporaneous zero restriction that allows the researcher to distinguish between interest rate and exchange rate innovations that are the result of domestic monetary policy shocks and those that are due to the monetary authorities' response to shocks to the exchange rate arising from speculative pressures, changes in the risk premium or foreign interest rate changes. In this study theres use the weight on the exchange rate in the short-run reaction This study uses a model of the money market and central bank operating procedures to test the different proposed identification schemes. This notion has inspired a number of central banks (e.g. the Bank of Canada and the Reserve Bank of New Zealand) to use a monetary conditions index (MCI) as operating target. The MCI is a weighted average of a short-term interest rate and a trade-weighted exchange rate and is used to measure changes in the stance of monetary policy in open economies. This solved the so-called N-1 problem which follows from the fact that with N currencies participating in a fixed exchange rate regime only N-1 bilateral exchange rates are fixed. For an account of the ERM experience and empirical evidence on the German dominance
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hypothesis, see Giavazzi and Giovannini (1989), Gros and Thygesen (1992) or De Grauwe (1994). The advantage of this strategy is that it is flexible enough to accommodate monetary policy regimes with a different emphasis on the exchange rate. As shown below, explicitly taking these differences into account is crucial for a credible identification of domestic monetary policy shocks and their effects. The disadvantage is that one needs to know the weight on the exchange rate. As there is only imprecise information concerning the role of the ECU exchange rate in the monetary policy strategy of France, Germany and Italy, which empirically estimate this weight over the period since the start of the ERM and various sub-periods and find that these estimates generally conform to what one would have expected on the basis of a description of the monetary policy regimes. The study estimate a four-variable identified VAR model comprising output, prices, a shortterm interest rate and the ECU exchange rate. The aim of the VAR analysis is to explain movements in these four endogenous variables in terms of four structural shocks: a supply shock, a demand shock, a domestic monetary policy shock and an exchange rate shock. In this the study now estimate the weight on the ECU exchange rate in France, Germany and Italy during the 1979-96 period using foreign interest rate and exchange rate innovations as instruments. As the emphasis on the exchange rate is likely to have changed over the sample period, estimates for relevant sub-samples are also provided. Estimated over the whole sample period, the weight on the ECU exchange rate is significant in both France and Italy, but not in Germany. In France, the weight is close to one as would be the case under pure exchange rate targeting and increases over the sample period as the commitment to the ERM parity firms. In Italy, the weight estimated over the whole period is considerably smaller than in France, partly reflecting the wider exchange rate band in the 1980s, and appears to have fallen during the estimation period. In particular, the estimated weight on the exchange rate is not significantly different from zero in the most recent period starting in September 1992, when the Italian lira was forced out of the ERM. For Germany our estimation strategy is less successful. Although one is unable to reject the hypothesis that the weight on the exchange rate during the estimation period is zero, in this case this finding may be the result of a lack of good instruments. In this the study had now estimated weights are then used to identify the monetary policy shocks and their effects on output, prices, the interest rate and the exchange rate. The estimated effects qualitatively conform to what one would expect in a standard open economy model. The monetary policy shocks lead to an appreciation of the currency in all three countries, so that the so-called exchange rate puzzles 2disappear. An analysis of the sensitivity of the estimated effects to changes in the assumed weight on the exchange rate confirms that the widely used zero contemporaneous restrictions are not always credible and may lead to
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econometric misspecification, in particular when dealing with financial prices such as interest rates and exchange rates that are simultaneously determined. The final section concludes. Incorporating the exchange rate in a structural VAR The identified VAR model is an attempt to explain movements in output, prices, the shortterm interest rate and the ECU exchange rate in France, Germany and Italy in terms of four structural shocks: a supply shock, a demand shock, a domestic monetary policy shock and an exchange rate shock. Identification It allows first deriving the supply and demand shocks, and then continuing with a discussion of the monetary shocks (i.e. policy and exchange rate shocks). Supply and demand shocks To distinguish the supply and demand shocks from the monetary shocks, an extended version of the Gerlach and Smets (1995) identification scheme is used. The study rely on a vertical long-run Phillips curve to assume that demand and monetary shocks have no long-run impact on the level ofreal output. Supply shocks are thus associated with the permanent shocks to output. Demand shocks are distinguished from monetary shocks by the widely used assumption that the latter do not contemporaneously affect real output. Shocks have a unit variance and are independent, allow us to estimate the supply and demand shocks and their impact on the policy variables, that is, the short-term interest rate and the exchange rate. Monetary policy and exchange rate shocks The focus of this study is on the identification of the two monetary shocks. Once the effects of supply and demand shocks on the interest rate and the exchange rate have been removed, the short-run reduced-form empirical model of monetary policy behaviour and the foreign exchange market. It is assumed that the central bank controls the domestic short-term interest rate and that it adjusts this instrument either to unilaterally change the stance of monetary policy exchange market disturbances due to adjustments in the risk premium, shifts in exchange rate expectations or foreign interest rate shocks. The main advantage of focusing on this weight to identify policy shocks is that it encompasses not only the two extreme cases of interest and exchange rate targeting but also the intermediate cases. The opposite extreme of exchange rate targeting may be appropriate for small open economies which use the exchange rate as their operating target. Such a regime existed, for example, in New Zealand from 1988 until 1996.
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It also applies to countries that operate under an adjustable peg regime such as France and Italy. One difference between an adjustable peg regime and the use of the exchange rate as operating target under a floating exchange rate regime is that in the former case there is a much more limited scope to change the desired target, for example to adjust to supply and demand shocks will be a one-to-one correspondence between domestic monetary policy shocks and exchange rate innovations as the central bank will not allow exchange market disturbances to affect the exchange rate. By the same token exchange rate shocks will be reflected in large interest rate movements. Finally, in most open economies with floating exchange rates the central bank's short-run reaction function will most probably correspond to an intermediate case whereby some positive weight is put on the exchange rate. An explicit example is Canada, which since 1987 has been using an MCI with = 0 25. As operating target. Germany is also likely to fall into this category. In this case the question arises: what is the optimal weight on the exchange rate? Central banks that use MCI shave based the weight on the relative importance of a 1% effective exchange rate appreciation and a 1percentage point interest rate rise in affecting aggregate demand. In the case of Canada, a weight of 0.25 is thus derived from the empirical finding that a 1 percentage point interest rate increase has three times as much effect on aggregate demand as a 1 % appreciation of the trade-weighted exchange rate. In Gerlach and Smets (1996), a simple open economy model is discussed in which the weights so determined can be shown to be optimal for a central bank that targets inflation. Although the focus on is useful to discuss the various identification options, in the case of France, Germany and Italy there is no precise information concerning its actual size apart from a suspicion that it is larger in France and Italy than in Germany? In what follows the strategy is therefore to first estimate the weight and then use that estimate to identify the policy shocks. The weight on the ECU exchange rate in France, Germany and Italy In this section the study estimates foreign interest rate and exchange rate shocks as instruments. However, before doing so, It describe changes in the monetary policy regime during the sample period. The monetary policy regime All three countries joined the ERM in March 1979. However, as Germany effectively became the anchor country, the exchange rate constraint was less binding for the Bundes bank. In fact, the Bundes bank continued to pursue a policy of monetary growth targeting during the whole ERM period, albeit in a flexible manner. For example, Tsatsaronis (1994) and Clarida and Gertler (1996) found that the Bundes bank responds quite strongly to changes in the DM/dollar exchange rate.
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In France and Italy, participation in the ERM implied a stronger policy focus on the exchange rate, although the commitment to the ERM parity has varied over time and between the two countries. Since 1979 the French authorities have pegged their currency in a narrow band of 2.25 % against the other ERM currencies. After the ERM crisis of July 1993 the ERM fluctuation bands were widened to 15 %, but many participating countries, including France, refrained from making full use of this increased exchange rate flexibility. While the period up to 1984 was characterised by frequent readjustments of the ERM parity grid (including several devaluations of the French franc against other ERM currencies), since then the French exchange rate commitment has firmed considerably, with the parity against the Deutsche Mark remaining unchanged since January 1987. The ERM band for the Italian lira was wider (6%) than that for the French franc until the end of the 1980s. After a brief period of adhering to the narrow fluctuation band of 2.25% (January 1990-September 1992), the Italian lira was forced to leave the ERM during the European exchange market crisis of September 1992. In this new regime of floating exchange rates, the policy focus was more directly geared towards inflation and inflation expectations. This brief description of the policy regimes suggests that one might expect a strong and increasing weight on the ECU exchange rate in France, a lower and, since 1992, falling weight in Italy and a still lower weight in Germany. Estimating the weight on the ECU exchange rate In order to obtain an empirical estimate of the weight on the ECU exchange rate during the ERM period, equation (4) is estimated using Hansen's (1982) general method of moments (GMM). For France and Italy, shocks to the US and German short-term interest rates and the DM/dollar exchange rate are used as instruments. For obvious reasons only the first instrument is available for Germany. For these instruments to be valid a necessary condition is that foreign interest rate and foreign exchange rate shocks are orthogonal to the policy shocks in (4). As the aim of the Study is to uncover purely domestic policy shocks and it is unlikely that such shocks would affect foreign interest rates or foreign exchange rates, this condition appears to be satisfied. The assumption also holds in the model presented in Gerlach and Smets (1996): foreign interest rate shocks do not affect the optimal MCI. Finally, a similar assumption has been used by Kim and Roubini (1995) in a set of two-country VARs including the United States, and by Clarida and Gertler (1996) in a VAR model for Germany. Table 1 reports the results of the GMM estimation for each of the countries and for various sub-samples which were identified on the basis of the description of the policy regimes above. For France and Italy the results are quite encouraging. I find that over the whole sample period the estimated weight on the ECU exchange rate is 0.75 in France and 0.38 in Italy. Not surprisingly, the hypothesis of pure interest rate targeting can be rejected in both cases. The hypothesis of pure exchange rate targeting can also be rejected, but only marginally so in the
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case of France. The difference between France and Italy is smaller when one only considers the period up to the ERM crisis of September 1992 (second row of Table 1). The weight on the ECU exchange rate is 0.66 in France and 0.53 in Italy. For France, the weight on the ECU exchange rate constantly over the sample period from 0.59 in the early ERM period to 0.84 in the period since the widening of the ERM bands, confirming that, as noted above, there was a firming of the exchange rate commitment. In fact, in the period since 1987 one cannot reject the hypothesis of pure exchange rate targeting, which is consistent with the fact that the French franc parity has not been changed during this period. In the case of Italy one finds that the weight on the ECU exchange rate has generally fallen over the sample period. Somewhat surprisingly, the estimated weight is higher in the early ERM period (1980:3-1983:12) than in the subsequent ERM period. Consistent with the change in exchange rate regime, the weight on the ECU rate since September 1992 is estimated to be very small and not significantly different from zero. The hypothesis of pure interest rate targeting thus cannot be rejected in this period. For Germany the results of the estimation are less successful. For completeness they are nevertheless reported in Table 1. The point estimate for Germany proves to be greater than one. However, the standard errors are so large that any weight between zero and one cannot be rejected. In fact, it appears that the only credible instrument available in this case (the US interest rate shock) is not a very good one. In what follows I assume that in Germany the weight on the ECU exchange rate is zero.
Comparing the effects of monetary policy in France, Germany and Italy In this section the study use the empirical weights estimated over the whole sample period to complete the identification of the VAR model discussed in Section 1 and analyse the resulting impulse response functions. To make a cross-country comparison easier, Graphs 1, 3, 4 and 5 combine the responses to a particular shock in each of the three countries. In these graphs each column gives the effect of a shock in a particular country, while each row focuses on the response of a particular endogenous variable. The last row of each graph shows the effect on the real MCI. Monetary policy shocks Graph 1 reports the effects of a domestic monetary policy shock. In all three countries a tightening of monetary policy is associated with an increase in the real interest rate and a real appreciation of the exchange rate, the combined effects of which are reflected in a rise in the real MCI. This finding is qualitatively consistent with open interest rate parity and shows that the so called exchange rate puzzle discussed by Grilli and Roubini (1995), whereby a positive interest rate shock leads to a depreciation of the exchange rate in a number of countries, does
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not arise if one properly takes into account the role of the exchange rate in the monetary policy strategy. Consistent with what one would expect in a standard open economy aggregate supply and demand model, this tightening leads to a significant fall in industrial production and a gradual fall in prices. Qualitatively, these results are very similar to the findings in Gerlach and Smets (1995). Accordingly, the contribution of policy shocks to output and prices is found to be negligible (Table 2). One exception is the case of France, where policy shocks explain about one-half of the forecast error variance of prices. Policy shocks do explain a significant fraction of the interest rate and exchange rate variability in the three countries. Interestingly, in Germany policy shocks account for about three-quarters of the forecast error in exchange rates.
Table-1 Forecast error variance decomposition One-year horizon Two-year horizon Four-year horizon Industrial production France Italy Germany 83 10 4 0 12 75 9 2 53 37 6 2 88 4 6 0 24 59 13 3 65 23 8 2 94 2 2 0 56 32 8 2 86 8 3 0
Consumer prices France Italy Germany 19 33 46 0 82 2 9 5 35 22 8 33 23 23 52 0 83 5 8 3 52 30 7 9 28 18 52 0 82 7 8 2 59 27 10 1
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Nominal interest rate France Italy Germany 17 24 22 35 13 11 48 25 29 53 7 9 17 23 26 33 23 11 42 22 41 41 10 7 20 22 27 30 29 11 39 20 45 35 12 6
ECU exchange rate France Italy 16 7 46 29 11 1 24 62 9 4 43 43 10 2 22 64 16 5 75 2 4 3 46 45 9 2 21 65 10 4 82 1
Germany 14 9 70 4
A sensitivity analysis In this subsection the sensitivity of the impulse responses of a monetary policy shock to changes in the assumed short-run weight on the exchange rate is examined. Overall, the choice of the weight does not seem to matter much in the case of Germany. The effect of a policy shock on the endogenous variables appears very robust to changes in the weight on the exchange rate from zero to one. A larger sensitivity of the impulse responses can be detected in France and Italy. In both countries the unrealistic assumption of a zero weight on the exchange rate would imply that a domestic policy shock has no significant effect on the exchange rate, which is inconsistent with basic models of exchange rate determination. The effects on the other endogenous variables are, however, hardly affected. Assuming the opposite extreme case of exchange rate targeting leads to serious misspecification in Italy, as in that case neither output nor prices are affected by a domestic monetary policy shock. In contrast, in France only the effect on the interest rate is significantly altered. In sum, the sensitivity analysis shows that the choice of the weight on the exchange rate matters for a correct specification of the monetary policy shock and its effects. Policy response to other shocks This shows that France and Italy speculative pressures on the exchange rate result in an appreciation of the currency and a fall in interest rates. The net effect of these interest rate and exchange rate movements on real monetary conditions is limited, which may explain the generally insignificant output and price effects of these shocks. In Germany, the main effect of the so-called exchange rate shock is to move prices temporarily higher, suggesting a misspecification which may be due to the fact that this kind of exchange rate shock has not been prevalent in Germany.
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The study showed that in France and Italy respectively, 43% and 64% of the exchange rate variability and 33% and 22% of the interest rate variability at the two-year horizon are attributable to foreign exchange market shocks. In contrast, in Germany the contribution of the exchange rate shocks to each of the endogenous variables at the two-year horizon is negligible. The estimated effects of supply and demand shocks on output, prices and interest rates is very much in line with previous findings, such as those in Gerlach and Smets (1995). In each country a positive supply shock leads to a significant fall in prices and the nominal interest rate, while a positive demand shock has the opposite effect on prices and interest rates. The exchange rate effects of these shocks are generally insignificant. This is not very surprising for two reasons. First, the exchange rate effect of a supply or demand shock will depend on whether it is an idiosyncratic shock or a shock common to other European countries. In the latter, more likely case one would expect only limited exchange rate effects. Second, even if the estimated supply and demand shocks were idiosyncratic, the fact that the three countries were participating in the ERM would tend to limit the effects on the ECU exchange rate. Conclusion This study had analysed the role of the ECU exchange rate in measuring monetary policy changes in France, Germany and Italy, three relatively open economies which have participated in the ERM since its inception in 1979. The main results of the analysis are twofold. First, I estimate the short-run weight on the ECU exchange rate in the monetary policy reaction function of these countries during the 1979-96 period and find, not surprisingly, that the weight on the ECU exchange rate is significant in both France and Italy, but not in Germany. In France, the weight has increased over the sample period and is not significantly different from one as would be the case under pure exchange rate targeting in the period since January 1987. In Italy, the weight estimated over the ERM period (1980:31992:8) is about one-half and therefore smaller than in France, partly reflecting the wider exchange rate band in the 1980s. However, in the most recent period starting in September 1992, when the Italian lira was forced out of the ERM, it has fallen to close to zero, which is consistent with a regime of interest rate targeting. Second, following Smets (1996), shows how the estimated short-run weight on the exchange rate can be used in VAR analysis to solve the identification problem that arises from the simultaneous determination of interest rates and exchange rates. I analyse the estimated effects of a domestic monetary policy shock on output, prices, the short-term interest rate and the exchange rate and find that the qualitative effects conform to what one would expect in a standard open economy model. In particular, explicitly taking into account the different role of the exchange rate in the monetary policy formulation of these countries allows us to solve the so-called exchange rate puzzle which has been documented in Grilli and Roubini (1995)
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What is monetary policy? Monetary policy is a tool used by the central bank to manage money supply in the economy in order to achieve a desirable growth. The central bank controls the money supply by increasing and decreasing the cost of money, the rate of interest. According to Prof. Harry Johnson, "A policy employing the central banks control of the supply of money as an instrument for achieving the objectives of general economic policy is a monetary policy." According to A.G. Hart, A policy which influences the public stock of money substitute of public demand for such assets of both that is policy which influences public liquidity position is known as a monetary policy." Monetary policy can either be expansionary or contractionary in nature. Under an expansionary policy, policy makers increase the money supply in the system by lowering interest rates. This is done mainly to boost economic growth and decrease level of unemployment. On the other hand, in contractionary policy, the cost of money is made dearer by increasing the rate of interest, which in turn helps in reducing the money supply in the system and combat inflation. Thus, while expansionary policy is followed to boost the economic growth, a contractionary policy is adopted to deal with an overheated economy situation. Objectives of monetary policy: Rapid growth Price stability Exchange rate stability Balance of payments (BOP) equilibrium Full employment Neutrality of money Equal income distribution
1. Rapid Economic Growth: It is the most important objective of a monetary policy. The monetary policy can influence economic growth by controlling real interest rate and its resultant impact on the investment. If the RBI opts for a cheap or easy credit policy by reducing interest rates, the investment level in the economy can be encouraged. This increased investment can speed up economic growth. Faster economic growth is possible if
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the monetary policy succeeds in maintaining income and price stability.
2. Price Stability: All the economics suffer from inflation and deflation. It can also be called as Price Instability. The monetary policy having an objective of price stability tries to keep the value of money stable. It helps in reducing the income and wealth inequalities. When the economy suffers from recession the monetary policy should be an 'easy money policy' but when there is inflationary situation there should be a 'dear money policy'. 3. Exchange Rate Stability: Exchange rate is the price of a home currency expressed in terms of any foreign currency. If this exchange rate is very volatile leading to frequent ups and downs in the exchange rate, the international community might lose confidence in our economy. The monetary policy aims at maintaining the relative stability in the exchange rate. The RBI by altering the foreign exchange reserves tries to influence the demand for foreign exchange and tries to maintain the exchange rate stability. 4. Balance of Payments (BOP) Equilibrium: Many developing countries like India suffer from the Disequilibrium in the BOP. The Reserve Bank of India through its monetary policy tries to maintain equilibrium in the balance of payments. The BOP has two aspects i.e. the 'BOP Surplus' and the 'BOP Deficit'. The former reflects an excess money supply in the domestic economy, while the later stands for stringency of money. If the monetary policy succeeds in maintaining monetary equilibrium, then the BOP equilibrium can be achieved. 5. Full Employment: The concept of full employment was much discussed after Keynes's publication of the "General Theory" in 1936. It refers to absence of involuntary unemployment. In simple words 'Full Employment' stands for a situation in which everybody who wants jobs get jobs. However it does not mean that there is a Zero unemployment. In that senses the full employment is never full. Monetary policy can be used for achieving full employment. If the monetary policy is expansionary then credit supply can be encouraged. It could help in creating more jobs in different sector of the economy. 6. Neutrality of Money: Economist such as Wicksted, Robertson have always considered money as a passive factor. According to them, money should play only a role of medium of exchange and not more than that. Therefore, the monetary policy should regulate the supply of money. The change in money supply creates monetary disequilibrium. Thus monetary policy has to regulate the supply of money and neutralize the effect of money expansion. However this objective of a monetary policy is always criticized on the ground that if money supply is kept constant then it would be difficult to attain price stability. 7. Equal Income Distribution: Many economists used to justify the role of the fiscal policy are maintaining economic equality. However in recent years economists have given the opinion that the monetary policy can help and play a supplementary role in attainting an economic equality. Monetary policy can make special provisions for the neglect supply such as agriculture, small-scale industries, village industries, etc. and provide them with cheaper credit for longer term. This can prove fruitful for these sectors to come up. Thus in recent
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period, monetary policy can help in reducing economic inequalities among different sections of society.
Instruments of the Monetary Policy: The instruments at the disposal of the RBI for managing money supply, interest rates and exchange rates are: Liquidity Management Cash Reserve Ratio Open Market Operations Managing Credit Expansion Interest rate Management Repo Rate Bank rate Rates paid on government securities Forex Management Tweaking the basket of currencies against which rupee rate is determined Market Intervention Liquidity Management Cash Reserve Ratio: Banks reserve liquidity through their power to create credit. Presently in India, banks are required to maintain the following reserves: Cash Reserve ratio: 8.25% of demand and time deposits (i.e. 24.05.2008) Statutory Liquidity ratio: 25% of demand and time deposits
Just as additional cash inflows enable the banking system to create credit, any increase in CRR will require the banking system to contract credit by a large amount. SLR (Statutory Liquidity ratio) is a requirement peculiar to India. In addition to ensuring that banks can fall back on the readily saleable government deposits in the event of a run on the bank, it was a prescription to divert bank deposits to meet government investment expenditure. Open Market Operations:
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Banks as well as other financial institutions, such as insurance companies, mutual funds and corporate with surplus cash are big investors in government securities. When RBI wishes to inject liquidity into the market, it has another option of buying government securities. When RBI offers to buy the securities at a rate that is better than the rate prevailing in the market, some of the investors can sell their holdings and the cash inflow would lead to credit creation of a large magnitude. Similarly, when RBI sells government securities at a higher rate than market rate, RBI absorbs funds and the banking system contracts credit by a large magnitude to reduce liquidity. This is known as open market operation. Managing Credit Expansion: CRR and OMO reduce liquidity in the system and reduce the ability of banks to create credit. RBI also controls sector specific expansion of credit by specifying maximum amounts that can be lent, minimum margins to be maintained and higher risk weights. When RBI feels that banks have overextended themselves to certain sectors, the flow of credit to certain sectors is leading to an imbalanced growth of the economy or it wants to control the price of certain commodities by preventing hoarding by wholesalers with borrowed funds, RBI makes sector specific or commodity specific interventions. Interest Rate Management Repo rate: Repo rate or repurchase rate is a swap deal involving the immediate sale of securities and simultaneous purchase of those securities at a future date, at a designated price. It could also be an overnight deal with sale taking place on day one and repurchase on day two. The repurchase price is adjusted for the interest payable for the use of funds for the period of contract. Reverse repo involves the immediate purchase and future sale of those same securities. RBI uses repo and reverse repo to control liquidity on a day-to-day basis. Bank rate: RBI provides refinance to banks against funds deployed by banks in specified sectors such as export finance portfolio of the banks. In the past, the bank rate used to be the primary interest rate tool of RBI. But over a period of time the repo rate has presently emerged as the primary interest rate tool and bank rate has lost much of its relevance. Changes in the bank rate are a signal to the market regarding the direction in which the RBI would like interest rates to move. Rates paid on government securities: RBI, as a banker to the government, helps government to borrow from the market by selling their securities. RBI also determines the timing, size, and rate paid on the issues. Rates offered by RBI on government securities are both a reflection of the market and also an indicator to the market on the direction of interest rate movements.
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Foreign Exchange Management Tweaking the basket of currencies: The exchange rate of rupee is calculated by RBI based on the exchange rates of basket of currencies of countries with which India has significant trade transactions. RBI maintains confidentiality about the weightage given to each currency in the basket and when RBI wishes to manage the extent of volatility in the exchange rate of rupee, RBI adjusts the weightages properly. Market intervention: Large balance of payment surpluses and build-up of Forex reserves are bound to strengthen the rupee in the exchange market. This market force cannot be counted by RBI for long periods of time. However, by intervening in the market by offering to buy any amount of foreign currency at a particular rate, RBI can prevent the sudden strengthening of rupee. RBI seeks to smooth the movement of rates in either direction so than importers and exporters have time to adjust to the changing exchange rate scenario and are not caught by surprise by violent rate movements, which could cripple them. Merits and demerits of monetary policy: Monetary policy refers to the actions taken by central banks, such as the Federal Reserve in the United States, the Bank of England and the Bank of Australia, to affect the money supply and the overall performance of their respective nations' economies. Central banks use shortterm interest rates, government securities and banking reserve requirements to affect the availability of money and credit in the economy. Like other forms of economic policy, monetary policy comes with a set of advantages and disadvantages. Merits: Low Inflation The two goals of monetary policy are to promote maximum sustainable levels of economic output and foster a stable price system. Stable prices mean keeping inflation low, and the Federal Reserve Bank of San Francisco concedes that low inflation is all that monetary policy can achieve in the long run. Inflation reduces the purchasing power of money, harming economic growth. In contrast, stable prices enable households and businesses to make financial decisions without worrying about sudden, unexpected price increases. Political independence When central banks operate free of political pressures, they are free to make policy decisions based on economic conditions and the best available data on economic performance, rather than short-term political considerations imposed by elected officials or political parties. The U.S. Federal Reserve operates with a high level of political independence, even though it is
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accountable to Congress. Federal Reserve board members are presidential appointees but have staggered terms to make it more difficult for a president to load the board with favourite appointees. When central banks lack this independence, monetary policy becomes subject to political pressures. Harvard economist Greg Mankiw, for example, writes that central bankers that lack political independence may manipulate monetary policy in a manner favourable to the political party in power. Demerits: Conflicting Goals The Federal Reserve and other central banks can use monetary policy to achieve low inflation in the long run and affect economic output and employment in the short run. The Federal Reserve Bank of San Francisco reports that these goals sometimes conflict. Reducing interest rates to expand the money supply and stem rising unemployment rates during a recession, for example, could spark future inflation if monetary policy remains expansionary for too long. The best monetary policy seeks to strike a balance between these short- and long-term goals. Time Lag In contrast to fiscal policy, which quickly stimulates additional money into the economy as governments increase spending for government programs and public projects, monetary policy actions take time to work their way through the economy, especially a large modern economy such as that of the U.S. and other world economic powers. The San Francisco Fed estimates that monetary policy actions to affect output and employment can take three months to two years for their effects to be felt. Actions may take even longer to affect inflation -- sometimes more than two years.
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Countries with monetary policy:
MONETARY POLICY OF INDIA Monetary policy in India underwent significant changes in the 1990s as the Indian Economy became increasing open and financial sector reforms were put in place. In the1980s, monetary policy was geared towards controlling the quantum cost and directions of credit flow in the economy. The quantity variables dominated as the transmission Channel of monetary policy .Reforms during the 1990s enhanced the sensitivity of price Signals of price signals from the central bank, making Interest rates the increasingly Dominant transmission channel of monetary policy in India. The openness of the economy, as measured by the ratio of merchandise trade (exports Plus imports)to GDP, rose from about 18%in 1993-94 to about 26% by2003-04. Including services trade plus invisibles, external transactions as a proportion of GDP Rose from 25% to40% during the same period .Along with the increase in trade as a Percentage of GDP, capital inflows have increased even more sharply ,foreign currency. Assets of the reserve bank of India (RBI) rose from USD15.1 billion in the march 1994 To over USD 140 billion by March 15; 2005.these changes have affected liquidity and monetary management. Monetary policy has responded continuously to changes in Domestics and international macroeconomic conditions. In this process, the current monetary operating framework has relied more on out right open market operations and Daily repo and reserve repo operations than on the use of direct instruments. Overnight Rate are now gradually emerging as the principal operating target The Monetary and Credit Policy is the policy statement, traditionally announced twice a year, through which the Reserve Bank of India seeks to ensure price stability for the economy. These factors include money supply, interest rates and the inflation. Objectives:The objectives are to maintain price stability and ensure adequate flow of credit to the Productive sectors of the economy. Stability for the national currency (after looking at prevailing economic conditions), growth in employment and income are also looked into. The monetary policy affects the real sector through long and variable periods while the financial markets are also impacted through short-term implications. There are four main 'channels' which the RBI looks 9at: Quantum Channel Money supply and credit (affects real output and price level through changes in reserves money, money supply and credit aggregates). Bank Rate Bank rate is the minimum rate at which the central bank provides loans to the commercial banks. It is also called the discount rate. Usually, an increase in bank rate results in commercial banks increasing their lending rates. Changes in bank rate affect credit creation by banks through altering the cost of credit.
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Cash Reserve Ratio: All commercial banks are required to keep a certain amount of its deposits in cash with RBI. This percentage is called the cash reserve ratio. The current CRR requirement is 8 percent CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which bank have to keep/maintain with the RBI. This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI controlling equality in the system, and thereby, inflation. Besides the CRR, banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements. The government securities (also known as gilt-edged securities or gilts) are bonds issued by the Central government to meet its revenue requirements. Although the bonds are long-term in nature, they are liquid as they can be traded in the secondary market. Since 1991, as the economy has recovered and sector reforms increased, the CRR has fallen from 15 per cent in March 1991 to 4.75 per cent in December 2012. The SLR has fallen from 38.5 per cent to 24 per cent over the past decade. Bank rate: 9.50%, CRR; 4.75%, Repo rate: 8.50%Reverse Repo rate; 7.50 %
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THE AUSTRALIAN MONETARY SYSTEM: Australian monetary system requires no minimum reserves of its banks. The Monetary Policy Framework The centre piece of the policy framework is an inflation target, under which the Reserve Bank sets policy to achieve an inflation rate of 2-3 per cent on average, a rate sufficiently low that it does not materially affect economic decisions in the community. The target provides discipline for monetary policy decision-making, and serves as an anchor for private sector inflation expectations. The target is agreed between the Bank and the Government. The Implementation of Monetary Policy: Monetary policy is set in terms of an operating target for the following: Cash rate: This is the interest rate on overnight loans made between institutions in the money market. When the Reserve Bank Board decides that a change in monetary policy should occur, it specifies a new target for the cash rate. A decision to ease policy will reflect in a new lower target cash rate, while a decision to tighten policy will reflect in a new higher target level for the cash rate. A decision by the Reserve Bank Board to set a new target for the cash rate is announced in a media release, which states the new target for the cash rate, together with the reasons why the Board has taken the decision to change it. This media release is distributed through electronic news services on the day on which the change is to take effect, usually at 9.30 am, the time when the Bank normally announces its daily dealing intentions. The Reserve Bank uses its domestic market operations, sometimes called open market operations, to influence the cash rate. On the days when monetary policy is being changed, market operations are aimed at moving the cash rate to the new target level. Between changes in policy, the focus of market operations is on keeping the cash rate close to the target, by managing the supply of funds available to banks in the money market - these latter operations are usually referred to as liquidity management Monetary Policy and Debt Management: Sound financial policy requires that the Government fully fund its budget deficit by issues of securities to the private sector at market interest rates, and not borrow from the central bank. Many countries have legislation to deliver this outcome, though in Australia it is effectively achieved by agreement between the Treasury and the Reserve Bank. This arrangement means that there is separation between monetary policy and the Government's debt management, with the Treasury directly responsible for the latter and the Reserve Bank responsible for the former. It is not possible to ensure that the budget deficit is exactly matched day-by-day by issues of securities to the market. For one thing, issues generally occur only weekly. To overcome this mismatch between daily spending and financing, the Treasury keeps cash balances with the Reserve Bank which act as a buffer. The Reserve Bank also provides an
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overdraft facility for the Government that is used to cover periods when an unexpectedly large deficit exhausts cash balances. The Objective of Monetary Policy: In Australia, the objectives of monetary policy are formally established in the Reserve Bank Act. The three main broad objectives are to maintain: Inflation at the targeted 2% to 3%
Board meets once a month to review a check list of economic indicators. This check list may include: Levels of consumption expenditure Indicators of future spending, for example, trends in housing loans Surveys of consumer and business confidence Trends in employment and unemployment Trends in business investment expenditure
External sector indicators such as the balance of payments, CAD and fluctuations in the exchange rate. The trends in the check list are then used to guide the Reserve Bank decisions on monetary stance. Overview: Monetary policy refers to the actions taken by the Reserve Bank of Australia (RBA) to affect monetary and financial conditions in the money market (also known as the cash market) to help achieve economic objectives of low inflation and sustainable growth. The Reserve Bank is the Governments monetary authority and is responsible for formulating and administrating monetary policy. To achieve non-inflationary growth the Reserve Bank sets a targeted cash rate. For example, the easing in monetary stance during 2001stimulated aggregate demand and increased economic growth.
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MONETARY POLICY OF CHINA The People's Bank of China was formerly the sole governor of both monetary policies and "commercial banking but has, as a result of the reforms of the post-1978period, come to serve as the primary monetary policymaking institution in China. It is the Chinese central bank (the equivalent of the U.S. Federal Reserve Banking System or the German Bundesbank). Premier Zhu's concerns about a financial sector crisis were grounded in recognition that China was quietly moving into the grips of a credit squeeze, wherein it was becoming increasingly difficult for firms to find financing for new investment and to pay for replacement of depreciating plant and equipment (old investment), and in some cases to finance operations. This credit squeeze was happening partly as a result of bank saving been granted greater autonomy in making loans. These banks, components of an elaborate government AL bureaucracy, had for years acted as state functionaries implementing a political plan for the economy. In this regard, bank officials approved politically-motivated loans to state-owned enterprises (SOE) that were also components in the bureaucracy and many of these past loans are in default. In other words, the bureaucratic machinery had become clogged when the lending process continued to function normally, providing a steady stream of money capital to the SOEs, but the claims (in the form of interest and principal payments) of the banks on SOE surplus value were not met: the flow was going in only one direction. Thus, when given the opportunity, even obligation, to unclog the machinery, the banks decided to sharply cut back on lending and the roll-over of existing debt, creating the first stages of a credit squeeze. This seemed, from the bankers stand point, to be the most rational response to a situation wherein their loan portfolios were pock-marked with bad loans. Indeed, books and articles in China have made a big deal of the fact that the banks had so many bad loans. It even seemed to be a civic duty for the bankers to get their house in order by tightening the standards for granting new loans or rolling over old ones. But, of course, the tightening of credit can lead to firms that are viable becoming unviable. It can lead to a wholesale deterioration in the health of the "real sector" of enterprises that produce needed goods. The People's Bank of China decided to head off this credit crunch by cutting the reserve requirement from between 16 and 20 percent (depending upon the size of the bank's asset base and other factors) to a single rate of 8 percent. The money multiplier (MM =1/RRR, where MM is the money multiplier and RRR is the required reserve ratio) tells us that a cut of this magnitude would double the lending capacity of the banking system. The hope is that banks will continue to provide loans to healthy" firms and avoid a financial sector crisis. We will discuss whether or not this is likely to succeed, but a key point that you should consider in this regard is not only whether or not banks will actually continue lending to the best available borrowers, but whether "healthy" firms would actually want to borrow under current conditions. If export growth is slowing, foreign direct investment is falling, and firms are starting to show strains in generating enough revenues to pay interest (and maturing principal) on loans, then we can conclude that the demand side of the Chinese economy is weakening. If the economy is weakening then firms are not as likely to be out aggressively hiring recent graduates or more workers. Some of the former graduate students I 9+workedwith in China
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have confirmed that the employment situation in China is not quite as good as it was in 1996 and 1997. There is some concern that the employment situation could get worse if the government doesn't counteract the aforementioned negative effects on aggregate demand for products and services. The Zhu administration is not willing to rely solely on monetary policy to keep the economy growing. He has also moved to stimulate spending directly. The Zhu administration has proposed a record budget with about 122billion dollars in spending for the coming fiscal year. This spending is designed to dramatically boost aggregate demand for goods and services (via the responding multiplier effect) and provide firms with the needed market for their output. If firms can sell their output and generate revenues, then they will be in a better position to pay the interest (and maturing principal) on their loans. The financial sector crisis, hopefully, can be averted and unemployment also reduced. These policies are designed to avoid the potential social unrest from an economic crisis. Premier Zhu and the rest of the Chinese leadership do not want to see anything like Indonesia's social problems within China's boundaries (or, even, the sort of unrest that is growing in Malaysia).In order to finance the government fiscal stimulus package, the Zhu administration has decided to take the Keynesian approach of increased deficit spending. Zhu Rongji's administration wants to partly finance the government budget by a record 44 billion dollars in government debt (double the debt issue of only three years ago). This debt would constitute about 36 percent of the total 122 billion dollars of expenditures in this year's budget with the remainder covered by government revenues from taxes and fees. Final approval of administration budgets comes from the national People's Congress, which has shown no inclination for going against the top leadership's proposals. In a further effort to avoid financial problems, the Zhu administration has also decided to finance special fund to recapitalize commercial banks (buy bad loans from the commercial banks and, therefore, add more to the capital base of the banks) by issuing almost 33 billion dollars in special 30-year bonds. This is in addition to the aforementioned 44 billion dollars in debt, bringing the total debt issuance to 77 billion dollars. The fact that the government is willing to borrow such a large amount is indicative of the concerns about an economic slow-down. The Chinese leadership has traditionally been much more conservative about their borrowing. The bond-balance-to-GDP ratio in China has grown from2.45 percent in 1991 to 4.2 percent last year. It is expected that this ratio will rise to 5.95 percent this year. This ratio is still a relatively modest bond-balance-to-GDP ratio and nothing like what one would find in Thailand or Indonesia or South Korea. However, the trend is somewhat troubling. At the moment, the rate of growth of the Chinese economy continues to exceed this bond-balance-to-GDP ratio, indicating that the Chinese economy can generate enough revenues to continue paying for the debt. In addition, the ratio of bondbalance-to-household-savings is expected to be about 9 percent this year, not a particularly large number either (especially given the relatively few options for Chinese household savers). This means the Chinese government should be able to find a ready market for these bonds. And China's overall debt load is miniscule compared to that of a country like Italy, which has a debt-to-GDP ratio of about 120%.These factors indicate that the Chinese government still has some flexibility in using debt to finance public expenditures and infrastructure investments. However, this also indicates that the current leadership is willing to mortgage" future revenues to pay for current spending. In other words, the current leadership is so concerned about the impact of an economic slowdown that they are willing to
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borrow much more heavily than has been traditional among the post-1949 governments and let someone else figure out how to pay the interest and principal. Does this sound familiar? China has avoided the worse of the Asia-wide economic crisis. Growth has slowed but is still both positive and greater in magnitude than the growth rates of most countries. If the pragmatic modernists are correct in their assumption that continued "modernization" is a prerequisite for social progress (for reinforcing socialism and clearing the path for communism), then we can view their current policies as not only an attempt to avoid social unrest and keep the leftists at bay, but also as consistent with their overall philosophy of building "socialism with Chinese characteristics."
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MONETARY POLICY OF SINGAPORE: The key objective of Singapore's monetary policy is to maintain price stability for sustained economic growth. Since1981, monetary policy in Singapore has been centred on the exchange rate. This reflects the fact that in the small and open Singapore economy where imports and exports amount to more than twice GDP, the exchange rate is the most effective tool in controlling inflation. The MAS manages the Singapore dollar (S$) exchange rate against a trade-weighted basket of currencies of Singapore's major trading partners and competitors. The composition of this basket is reviewed and revised periodically to take into account changes in Singapore's trade patterns. This trade-weighted exchange rate is maintained broadly within an undisclosed target band, and is allowed to appreciate or depreciate depending on factors such as the level of world inflation and domestic price pressures. MAS may also intervene in the foreign exchange market to prevent excessive fluctuations in the S$ exchange rate. Monetary policy is reviewed on a semi-annual basis to ensure that it is consistent with economic fundamentals and market conditions, thereby ensuring low inflation for sustained economic growth over the medium term. The MAS publishes a semi-annual Monetary Policy Statement (MPS) in April and October which explains its assessment of Singapore's economic and inflationary conditions and outlook, and sets out its monetary policy stance for the following six months. Singapores exchange rate-based monetary policy system and its experience since its adoption are reviewed in MAS' monograph on Singapore's Exchange Rate Policy .In the context of Singapore's open capital account, the choice of the exchange rate as the focus of monetary policy would necessarily imply that domestic interest rates and money supply are endogenous. As such, MAS' money market operations are conducted mainly to ensure that sufficient liquidity is present in the banking system to meet banks' demand for reserve and settlement balances. The key aspects of MAS' monetary policy operations, viz. foreign exchange and money market operations, and the various factors and considerations underlying them, are discussed in MAS' monograph on Monetary Policy Operations in Singapore.
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MONETARY POLICY OF JAPAN: Monetary policy pertains to the regulation, availability, and cost of credit, while fiscal policy deals with government expenditures, taxes, and debt. Through management of these areas, the Ministry of Finance regulated the allocation of resources in the economy, affected the distribution of income and wealth among the citizenry, stabilized the level of economic activities, and promoted economic growth and welfare The Ministry of Finance played an important role in Japan's post-war economic growth. It advocated a "growth first" approach, with a high proportion of government spending going to capital accumulation, and minimum government spending overall, which kept both taxes and deficit spending down, making more money available for private investment. Most Japanese put money into savings accounts, mostly postal savings. National Budget: In the post-war period, the government's fiscal policy centres on the formulation of the national budget, which is the responsibility of the Ministry of Finance. The ministry's Budget Bureau prepares expenditure budgets for each fiscal year based on the requests from government ministries and affiliated agencies. The ministry's Tax Bureau is responsible for adjusting the tax schedules and estimating revenues. The ministry also issues government bonds, controls government borrowing, and administers the Fiscal Investment and Loan Program (FILP), which is sometimes referred to as the "second budget." Three types of budgets are prepared for review by the National Diet each year. The general account budget includes most of the basic expenditures for current government operations. Special account budgets, of which there are about forty, are designed for special government programs or institutions where close accounting of revenues and expenditures is essential: for public enterprises, state pension funds, and public works projects financed from special taxes. Finally, there are the budgets for the major affiliated agencies, including public service corporations, loan and finance institutions, and the special public banks. Government fixed investments in infrastructure and loans to public and private enterprises are about 15 % of GNP. Loans from the Fiscal Investment and Loan Program, which are outside the general budget and funded primarily from postal savings, represent more than20 % of the general account budget, but their total effect on economic investment is not completely accounted for in the national income statistics. Government spending, representing about 15 % of GNP in 1991, was low compared with that in other developed economies. Taxes provided 84.7 %of revenues in 1993. Income taxes are graduated and progressive. The principal structural feature of the tax system is the tremendous elasticity of the individual income tax. Because inheritance and property taxes are low, there is a slowly increasing concentration of wealth in the upper tax brackets. In 1989 the government introduced a major tax reform, including a 3% consumer tax. This tax has been raised to5 % by now. After the breakdown of the economic bubble in the early 1990s the country's monetary policy has become a major reform issue. US economists have called for a reduction in Japan's public spending, especially on infrastructure projects, to reduce the budget deficit. To force a reduction of the loan program, partially financed through postal savings, then-Prime Minister Junichiro Koizumi aimed to
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push forward postal privatization. The postal deposits, by far the largest deposits of any bank in the world, would help strengthening the private banking sector instead Budget process: The Budget Bureau of the Ministry of Finance is at the heart of the political process because it draws up the national budget each year. This responsibility makes it the ultimate focus of interest groups and of other ministries that compete for limited funds. The budgetary process generally begins soon after the start of a new fiscal year on April 1.Ministries and government agencies prepare budget requests in consultation with the Policy Research Council. In the fall of each year, Budget Bureau examiners reviews these requests in great detail, while top Ministry of Finance officials work out the general contours of the new budget and the distribution of tax revenues. During the winter, after the release of the ministry's draft budget, campaigning by individual Diet members for their constituents and different ministries for revisions and supplementary allocations becomes intense. The coalition leaders and Ministry of Finance officials consult on a final draft budget, which is generally passed by the Diet in late winter.
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THE UNITED STATES MONETARY SYSTEM: During the colonial period, coins from different European countries were used and circulated throughout the colonies. Spanish coins were the dominate currency and because of the scarcity of coins, much of the trade and commerce was accomplished by bartering and trade, and commodities such as rice, tobacco, animal skins, and rum,were actually used as money Paper notes and other currencies were issued by some of the colonies with varying rates of discount which made them little more than worthless and not acceptable for most purchases or for payment of any kind. During the American Revolution, the Continental Congress issued the first unified currency which was declared redeemable in gold and silver but after the war and independence, redemption became almost nil because of excessive printing of the notes over metal reserves and the notes lost almost all of their value. Because of a sharp rise in population and a big increase in trade and commerce, the newly formed United States government started looking at ways to institute a strong, stable, central monetary policy It wasn't until 1792 that Congress was given the power to create and establish a national monetary system. At that time, Congress passed the Coinage Act and made the dollar the nations primary monetary unit. The Coinage Act of 1792 was based on the use of gold and silver reserves but because of the scarcity of the precious metals at the time, adjustments in value occurred frequently. Throughout U.S. history, especially after gold was discovered in California, revision of the coin age laws and the mint ratio of gold and silver coins increased or decreased as the economics of the times dictated. In 1913, the Federal Reserve Act was passed authorizing the establishment of regional Federal Reserve Banks (Federal Reserve System) that issue money to member banks by drawing on their own deposits or by borrowing commercial paper if their deposit balances with the Federal Reserve are insufficient. The United States monetary system is designed to have the flexibility to meet the needs of the general population and to stimulate the economy when stimulation is deemed necessary.
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How Does Monetary Policy Impact the Economy? What Is the Monetary Policy Transmission Mechanism? Because of the impact monetary policy has on financing conditions in the economy (not just the costs, but also the availability of credit or banks willingness to assume specific risks) but also because of its influence on expectations about economic activity and inflation, monetary policy can affect the prices of goods, asset prices, exchange rates as well as consumption and investment. Interest rate cuts, for example, lower the cost of borrowing, which results in higher investment activity and the purchase of consumer durables. The expectation that economic activity will strengthen may also prompt banks to ease lending policy, which in turn enables businesses and households to boost spending. In a low interest-rate environment, shares become a more attractive buy, raising households financial assets. This may also contribute to higher consumer spending, and makes companies investment projects more attractive. Lower interest rates also tend to cause currencies to depreciate: Demand for domestic goods rises when imported goods become more expensive. All of these factors raise output and employment as well as investment and consumer spending. However, this stepped-up demand may cause prices and wages to rise if goods and labour markets are fully utilized. The process through which monetary policy decisions impact on an economy in general and the price level in particular is known as the monetary policy transmission mechanism. The individual links through which monetary policy impulses proceed are known as transmission channels. The main channels of monetary policy transmission are set out in a simplified, schematic form in the chart. The Impact of Monetary Policy Impulses on the Economy Every monetary policy impulse (e.g. an interest rate change by the central bank, change in the monetary base resulting from changes in the minimum reserve rate) has a lagged impact on the economy. Moreover, it is uncertain how exactly monetary policy impulses are transmitted to the price level or how real variables develop in the short and medium term. The difficulty of the analysis is to adjust the effects of the individual channels for external factors. The effect of such external factors e.g. supply and demand shocks, technical progress or structural change may be superimposed on the effect of central bank measures, and it is difficult to isolate monetary policy effects on various variables for analytical purposes. Moreover, the time lag in the reaction of the real sector to monetary measures renders the analysis more difficult. Hence, monetary policy must be forward looking.
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The individual transmission channels are described in detail below: Interest rate channel: An expansion of the money supply by the central bank feeds through to a reduction of short-term market rates through this channel. As a result, the real interest rate and capital costs decline, raising investment. Additionally, consumers save less and opt for current consumption over future consumption. This, in turn, causes demand to strengthen. However, this stepped-up demand may cause prices and wages to rise if goods and labor markets are fully utilized. Credit channel: The credit channel in effect breaks down into two different channels: Bank lending channel: Central banks monetary policy decisions influence commercial banks refinancing costs; banks are inclined to pass the changes on to their customers. If financing costs diminish, investment and consumer spending rise, contributing to an acceleration of growth and inflation. However, following an increase in interest rates, the risk that some borrowers cannot pay back their loans in due course may increase so much that banks will not grant loans to these borrowers. As a result, borrowers would be forced to cut back on planned expenditure. Balance sheet channel: Monetary policy may have a direct impact on corporate policy, because companies may borrow to improve return on equity as long as the return on debt in effect the lending rate is lower than the return on assets. Hence, the return on assets is a weighted arithmetic mean of the return on equity and the lending rate, which are respectively weighted by the share of equity and debt in total assets. Consequently, lower interest rates improve the return on equity. For this reason, non profitable enterprises may show a positive return on equity. However, this may reinforce the influence of interest rates on investment behaviour, which is referred to as the financial accelerator effect. Exchange rate channel: Expansionary monetary policy affects exchange rates because deposits denominated in domestic currency become less attractive than deposits denominated in foreign currencies when interest rates are cut. As a consequence, the value of deposits denominated in domestic currency declines relative to that of foreign currency-denominated deposits and the currency depreciates. This depreciation makes domestic goods cheaper than imported goods, causing demand for domestic goods to expand and aggregate output to augment. This channel does not operate if a country has a fixed exchange rate; conversely, the more open an economy is, the stronger this channel is. Exchange rate fluctuations may also influence aggregate demand by affecting the balance sheets of banks and companies whose balance sheets include a large share of foreign currency-denominated debt. Interest rate reductions that entail a depreciation of the national currency raise the debt of domestic banks and companies which have foreign currency-denominated debt contracts. Since assets are typically denominated in domestic currency and therefore do not increase in value, net worth declines automatically. If balance sheets deteriorate, the risk that some borrowers cannot pay back their loans in due course may increase so much that banks will not grant loans to these borrowers. As a result, borrowers would be forced to cut back on planned expenditures.
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Wealth channel: Monetary policy impulses are also transmitted through the price of assets such as stocks and real estate. Fluctuations in the stock or real estate markets that are influenced by monetary policy impulses have important impacts on the aggregate economy. The expansionary monetary policy effects of lower interest rates make bonds less attractive than stocks and result in increased demand for stocks, which bids up stock prices. Conversely, interest rate reductions make it cheaper to finance housing, causing real estate prices to go up. There are three different types of transmission mechanisms involving asset prices: 1. Investment effects: Tobins q theory explains an important mechanism through which movements in stock prices can affect the economy. Tobins q is defined as the market value of firms divided by the replacement cost of capital. If q is high, the market price of firms is high relative to the replacement cost of capital, and new plant and equipment capital is cheap relative to the market value of firms. Companies can then issue stock and get a high price for it relative to the cost of the facilities and equipment they have bought. Investment spending will rise because firms can now buy a relatively large amount of new investment goods with only a small issue of stock. An interest rate cut entailing a rise in stock prices will therefore reduce companies capital costs and consequently boost investment spending.
2. Wealth effects: Modiglianis life cycle model states that consumption is determined by the lifetime resources of consumers. These life cycle resources consist primarily of financial assets, mostly stock, and real estate. Interest rate cuts entail a rise in stock and real estate prices and accordingly boost household wealth. At the same time, consumers life cycle resources expand, in turn lifting consumer spending and aggregate demand. 3. Balance sheet effects: A rise in stock and real estate prices improves corporate and household balance sheets alike. Higher net worth translates into higher collateral for lending to companies and households. This, in turn increases lending, investment spending and hence, higher aggregate spending.
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Monetary Policy and Financial Stability Basic Information In view of the progressive global integration of financial and capital markets, capital mobility and the international links between financial intermediaries, central banks must cope with the challenge of securing financial stability. Financial stability is not just a prerequisite for the effective implementation of monetary policy via the transmission mechanism of banks and financial systems; financial stability also provides the corporate sector with a reliable setting for planning and enhances businesses propensity to invest and innovate. In accordance with Article 105(5) of the Treaty, the ESCB contributes to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system. Central banks must have reliable up-to-date information about financial and capital markets as well as financial intermediaries to be able to recognize and react in a timely manner to any financial market destabilization, such as financial crises. To this end, the ECB and the Euro system systematically monitor cyclical and structural developments in the banking sector of the EU and in other financial sectors, with a focus on: Any systemic weaknesses of the financial sector, and Its resistance to potential shocks.
In assessing these factors, the ECB cooperates with the EU national central banks and the supervisory authorities. Within the ECB, the financial stability monitoring entails extensive involvement by several business areas (Financial Stability as coordinator, Economics, Operations, International and European Relations and Payment Systems). Detailed Information Economic Analysis and Financial Stability Financial stability denotes the state in which a financial system is capable of absorbing shocks without triggering cumulative processes that hamper the provision of savings for investment and the smooth processing of payments in the economy. Hence, the monetary policy strategy, consisting of economic analysis and monetary analysis, aids the assessment of the risk of excessive borrowing, which affects financial stability and may cause bubbles to arise. In addition, monetary analysis provides information about anomalies in the financial environment as a whole. The interaction between the household and nonfinancial corporation sectors in an economy the size of the euro area is crucial for the analysis and projection of economic developments. It is also essential to keep tabs on portfolio changes in household net lending/borrowing and its links to interest rate movements and investment in housing. Moreover, it is important to understand shifts between internal and external finance in the financing of nonfinancial corporations, as well as corporate investment and profitability.
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The importance of this analysis should be seen against the background of the ongoing integration of European financial markets, which has accelerated in the wake of the introduction of the euro and the single monetary policy. More integration is tantamount to closer links between financial institutions, markets and market infrastructure. Greater liquidity and highly integrated financial markets may reduce the probability of systemic shocks. However, any shocks that may occur will also be more likely to extend beyond national borders, which also mean that they could become large enough to present a systemic risk for the entire euro area.
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Indian monetary policy and the RBI Lets focus upon inflation The Reserve Bank of India (RBI) has acted according to expectations in attempting to restrain inflationary concerns and sustain gross domestic product (GDP) growth rate by freeing up investment demand. I doubt it is possible to argue against the RBI moving to a tighter monetary policy stance in the given circumstances. But in its latest move, the RBI has underestimated the inflationary risks and not acted strongly enough in a situation where it faces substantially greater pressure on liquidity management and where global commodity prices could be rather volatile, and possibly move upwards. The RBI should have set a lower growth rate target. The RBI projects GDP growth rate for 2010-11 at 8 per cent with the possibility of an increase. But the RBI has overlooked some major risks to GDP growth. The first risk, which the RBI admittedly acknowledges, is the worrying developments in the external sector of the Indian economy. In 2009-10, India is estimated to have ended up with an exceptionally large current account deficit 4.1 per cent of GDP. The relative size of this deficit becomes apparent when it is compared with the current account deficits of 2.4 per cent of GDP in 2008-09 and 3 per cent of GDP in 1990-91, the latter being the year of the twin crises. Normally, such a large deficit should produce a depreciation of the exchange rate so as to achieve better external balance. But the rupee actually appreciated by 15 per cent in 200910 (till February) against a depreciation of 10.4 per cent in 2008-09. This appreciation will act as a strong constraint to prevent the economy benefiting from higher external demand. Moreover, with the persistence of accommodative monetary policy in the OECD economies, India will attract greater foreign capital flows which will further push up the exchange rate. This factor could be handled if the RBI had the space to sterilize the larger inflows. But it does not, because the governments borrowing program has had to be financed by the issuance of fresh securities, which will be 36 per cent higher than current securities. The RBI governors statement pithily stated the central banks dilemma: While monetary policy considerations demand that surplus liquidity be absorbed, debt management considerations warrant supportive liquidity conditions. Like the large current account deficit, these higher bond yields will dampen investor sentiment. The second risk to GDP growth is contained in Indias extreme dependence on investment demand to sustain growth. This risk is obvious when one looks at the major sources of Indian GDP growth in past years; public expenditure, private consumption and imports, and investment demand. As to public expenditure, in 2010-11 India plans to wind back public expenditure so as to order to achieve a stipulated reduction of the fiscal deficit of 1.2 per cent of GDP. This decrease will reduce the contribution of government demand to GDP growth to less than 14 per cent of what it was in 2009-10. As to private consumption and imports, in 2009-10, private consumption accounted for 36 per cent of GDP and net exports contributed a whopping 20 per cent. The large contribution
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of net exports was a complete contrast with the prevailing trend of negative 8 per cent contribution of net exports to GDP growth during the period 2001-08, and was only achieved because imports slumped much more than exports. With imports rising by 66 per cent in February, net external demand will become negative again in 2010-11. Similarly, private consumption demand will decrease because the effects of the (one-time) Sixth Pay Commission awards and farm debt waiver will wear off. Rising prices of manufactured goods will also weaken private consumption. We are thus left only with investment demand, which contributed a measly 26 per cent to GDP growth in 2009-10. Investment demand is admittedly on the rise, with non-food credit off-take increasing to 16.9 per cent by March 2010 compared with 17.3 per cent in 2008-09. But it is still weak. It could also be argued that GDP growth will be bolstered by the steady increase in the growth rate of capital goods imports since September. But the business expectation index has begun to moderate. And the hike in banks lending rates, which has already been announced, could further weaken investors intentions. Worryingly, more hikes are likely as a result of tightened monetary policy, and increased security-funded government borrowing. Finally, the appreciating rupee will dampen capacity expansion and employment generation in the exportoriented sector. In sum, it would have been more realistic for the RBI to target a lower GDP growth rate of 6.5-7 per cent. A lower growth target, still stellar when compared to an expected global growth rate of 3.6 per cent in 2010-11, would have allowed the RBI to take a more robust approach to tackling inflation expectations. Such a target would also have signaled to the government that it needed to pursue second-generation structural reforms more vigorously. That alone would have raised the growth rate of potential output. As a related aside, the RBIs estimate of wholesale price index inflation 5.5 per cent in March 2011 is perhaps too low. According to ICRIERs estimates, inflation is set to rise in the coming months, will remain in double digits until around October, and will then decline to 7-8 per cent by March 2011 if there is no further stress on food supplies or a rise in global oil and commodity prices. The RBI should have acted more decisively to try and get ahead of the inflation curve. Ultimately, the Indian economy will be benefited most by the implementation of structural reforms, and the limitation of government borrowing.
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Indias experience with capital controls A combination of structural and cyclical factors has triggered a new wave of portfolio capital flows into emerging market economies. Incorporating the fresh lessons learnt from the 2008 crisis, the policy toolkit of emerging markets economies has now been expanded to include capital controls. The IMF is in the process of endorsing this policy approach. In this context Indias experience is worth examining. Indias strategy for managing the capital account was developed initially to deal with the capital inflows boom that preceded the GFC (2006-7). Indias macro-monetary framework allowed policymakers to steer within the intermediate zone of the open-economy trireme and to achieve domestic price objectives while addressing exchange rate concerns even in the face of a prolonged and heavy surge in capital inflows. The first element in Indias strategy was to increase the stock of foreign exchange reserves by US$ 57 billion in 2006-07 this level is well above the average in the preceding five years. The main reason for the accelerated pace of reserve accumulation was the increase in the capital account surplus, driven by a sharp rise in net non-FDI capital flows. However, the heavy capital inflow severely strained the monetary base. Reserve money growth ran above 17 percent year-on-year in 2006, accelerating further to 30 percent for most part of 2007 and money supply was running close to 25 per cent. The increased liquidity allowed banks to increase the pace of lending beyond that justified by strong economic growth and other fundamentals by rapidly running down their stock of investments in government bonds and loaning close to three-fourths of their deposits by 2006-07. To limit the monetary impact of intervention and restrain the growth of reserve money, the central bank sterilized the foreign exchange inflows. Between March-December 2007, the RBI sterilized almost 43 per cent of its net foreign exchange purchases on average, allowing partial feedback into money supply. The second element in Indias strategy was greater exchange rate flexibility. The degree of exchange rate flexibility can be shown through an index measure derived from the relationship between the nominal exchange rate and foreign exchange reserves, or the idea of exchange market pressure. The index of exchange rate flexibility increased from 0.85 in April 2006 to 0.91 from May 2007 onwards, reflecting a rise in flexibility relative to historical levels and in comparison to both advanced (Japan) and emerging economies (Mexico). Real appreciation averaged over 2 per cent each month from May to August 2007. The domestic currency appreciated vis--vis the US dollar in nominal terms too by over 9 per cent in 2007, relative to 2006 levels. As capital inflows intensified from May 2007, nominal appreciation exceeded 11 percent annually for ten successive months. Another element in the strategy to manage capital inflows was interest rate control that was possible due to existing restrictions on debt inflows by foreigners. India also had to manage the exploitation of carry-trade arbitrage by market agents and residents converting cheaper
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borrowings in foreign currencies into rupee deposits placed with the central banks overnight liquidity adjustment facility (LAF). In response, the width of the corridor was widened steadily from the end of 2006 from 100 bps to 175 bps by April 2007 to deter one-way bets by foreign investors. The central bank also addressed the arbitrage trade by capping absorption through the reverse repo window at Rs 30 billion daily in March 2007. Finally, as the prolonged surge in capital inflow persisted and currency appreciation pressures remained unabated, policymakers capped residents access to foreign currency borrowings and prohibited conversion of foreign currency loans into rupees in August 2007. Specifically, outright caps were imposed upon foreign loans above US$ 20 million for domestic expenditures. Also restricted were participatory notes (PNs), an offshore derivative product allowing overseas retail investors exposure to the Indian stock market. The Indian authorities used these various techniques strategically to manage capital inflows and navigate the monetary policy trireme. One advantage of having a number of components to the strategy was that it allowed the authorities to avoid the undesirable consequences associated with overuse of one or another instrument for a prolonged period. This was an effective strategy that in conjunction with a restricted debt market assisted in preserving monetary independence amidst an environment of strong growth and overheating pressures. Based on this experience and evidence, it appears that the Indian central bank was able to retain monetary control. In other words, capital controls were effective in maintaining the wedge between domestic and foreign interest rates, an essential condition for pursuing an independent monetary policy. This conclusion is in line with other empirical work on the efficacy of capital controls, which demonstrates that the area where capital controls have been most successful is in providing more autonomy for monetary policy.
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Indias exchange rate policy: weighing the trade-offs The recent depreciation of the rupee has been a costly shock for Indias financial and real economy. The large and abrupt drop in the currencys value has negatively impacted businesses and households by pushing up costs in an inflationary phase, increased price uncertainty and volatility, dented economic confidence, and worsened the critical macroeconomic aggregates. The near free fall of the rupee and its disastrous fallout raises an important public policy issue: is it worth keeping intervention as an additional tool at Indias disposal? It is clear that intervention is no longer a policy option at the Reserve Bank of India (RBI) its belated and feeble intervention makes this apparent. But the current experience provides an opportunity to critically examine the trade-offs of Indias macroeconomic policy choices in recent years. In 201011 capital inflows were buoyant, aggregating US$60 billion. The exchange rate adjusted fully to this inflow with a nominal appreciation of an average of 4 per cent year-onyear each month, and the adjustment in real effective terms was double this. Monthly inflation averaged a very high 10 per cent, while both oil and non-oil imports grew briskly at an average of 20 per cent every month. With nearly 80 per cent of oil supplies coming from abroad, there is little doubt about the role a stronger currency might have played in restraining imported inflation. Exchange rate appreciation also allowed authorities to lessen the weight assigned to interest rates for monetary tightening that domestic inflationary conditions demanded. A hands-off exchange rate policy was helpful on other counts as well. What, for example, might have been the fiscal cost of intervention in an inflationary phase? This cost arises from the RBI exchanging foreign currency purchases for rupee assets called Market Stabilization Bonds (MSBs) to limit feedback into the domestic money supply. Because rupee interest rates are higher relative to foreign currency, the differential interest cost devolves onto the government balance sheet. Assuming RBI had bought half the net capital inflow in 2010-11 ($30 billion) and sterilised the purchase, the quasi-fiscal cost would have been roughly Rs 62.47 billion or 0.13 per cent of GDP. How much pressure would have been placed on the yield rate from additional issues of government bonds, in addition to the budgeted market borrowings of Rs 3.45 trillion? This is difficult to predict but it is doubtful a bond supply of nearly Rs 4.8 trillion (US$98 million) would have resulted in an average long-bond yield rate of 7.9 per cent as it did in 201011. The current financial year can serve as a rough guide for expected borrowings of more than Rs 5 trillion (US$102 million) pushed bond yields beyond 8.75 per cent in November. This forced the government to lift caps on foreign investment in sovereign bonds and the RBI to regularly manage yields through open-market operations. So there is little doubt that a nointervention policy averted pressure on the yield rate in 201011.
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But the wheels of fortune can turn. The fuel subsidy bill is expected to overshoot the budgeted amount by Rs 1 trillion (US$20 million) due to higher fuel costs from the rupees depreciation. And extra expenditure from revenue losses due to fuel tax cuts and additional interest outgo from unscheduled market borrowings will impact the fiscal deficit that is expected to exceed by at least one percentage point. Apart from the fiscal damages, the unrestrained fall of the rupee is pushing up domestic inflation, which is of serious concern to the RBI. Harder to quantify are the injuries to the private sector, viz. sudden and large increase in external repayment obligations, shelved investment spending due to difficulties in raising additional financing and extreme price volatility. Against this outcome, was it worth keeping intervention as an additional policy tool? An extra firepower of some US$30 billion, accumulated when capital inflows were strong, may have facilitated early and decisive intervention to mitigate the unanticipated shock of the capital flows reversal in 201112. And adjusting the nearly Rs1.48 trillion (US$30.2 million) spent in over-generous subsidies could have reduced pressure on yields in 201011. This would have translated into a stronger fiscal position for 201112. In conjunction with a stronger reserves position, this would have provided greater policy room to manoeuvre unanticipated shocks. As with any macroeconomic story, this one, too, can be told differently. But since all tradeoffs represent conscious policy choices, it is fair to question whether the hands-off exchange rate policy was a deliberate one to check imported inflation.
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Case study (U.S.A) Who makes monetary policy? The Feds FOMC (Federal Open Market Committee) has primary responsibility for conducting monetary policy. The FOMC meets in Washington, D.C., eight times a year and has twelve members: the seven members of the Board of Governors, the President of the Federal Reserve Bank of New York, and four of the other Reserve Bank Presidents, who serve in rotation. The remaining Reserve Bank Presidents contribute to the Committees discussions and deliberations. In addition, the Directors of each Reserve Bank contribute to monetary policy by making recommendations about the appropriate discount rate, which are subject to final approval by the Governors. What about foreign currency operations? Purchases and sales of foreign currency by the Fed are directed by the FOMC, acting in cooperation with the Treasury, which has overall responsibility for these operations. The Fed does not have targets, or desired levels, for the exchange rate. Instead, the Fed gets involved to counter disorderly movements in foreign exchange markets, such as speculative movements that may disrupt the efficient functioning of these markets or of financial markets in general. For example, during some periods of disorderly declines in the dollar, the Fed has purchased dollars (sold foreign currency) to absorb some of the selling pressure. Intervention operations involving dollars, whether initiated by the Fed, the Treasury, or by a foreign authority, are not allowed to alter the supply of bank reserves or the funds rate. The process of keeping intervention from affecting reserves and the funds rate is called the sterilization of exchange market operations. As such, these operations are not used as a tool of monetary policy Exchange Rate Pass-Through and Monetary Policy Since 2002, the U.S. dollar has depreciated over 40 percent against a basket of major currencies, weighted by their countries' trade with the United States. Over the past two years, the trade-weighted dollar has fallen by 15 percent. The decline in the value of the U.S. dollar, particularly if it continues, has raised concerns that it might lead to higher inflation. After all, a lower value of the dollar is likely to raise the cost of imports, which can feed into higher consumer prices. But how much of a risk to inflation is posed by a depreciation of the domestic currency? This depends on how much of the falling value of the currency is passed through to import prices and then on to overall consumer prices. In my remarks today, I will discuss what recent economic research tells us about exchange rate pass-through and what this suggests for the control of inflation and monetary policy. I will first focus on exchange rate pass-through from a macroeconomic perspective and then examine the microeconomic evidence. In light of this evidence, I will then discuss the implications of exchange rate movements on the conduct of monetary policy.1 Traditional Monetary Explanations of Currency Depreciation There is a long history behind the belief, often expressed in the popular press, that nominal
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exchange rate depreciation is closely linked to price inflation. Even prior to the U.S. Constitutional Convention of 1787, policymakers recognized that monetary systems without a nominal anchor--that is, systems which relied on paper money not backed by gold or other commodities--were prone to large currency devaluations and high inflation. The lack of a nominal anchor is one of the reasons the U.S. Constitution restricted the states from issuing their own currencies (Michener and Wright, 2005). Traditional monetary theory regards excessive money creation as a common source of instability in both the exchange rate and price level. In the presence of large monetary shocks, price inflation and exchange rate depreciation should, therefore, be closely linked. The large exchange rate depreciation and coincident inflation that occurred following many episodes of wartime suspension of the gold standard--including those in Britain during the Napoleonic Wars and after World War I--were often cited in support of the traditional monetary interpretation (Frenkel, 1976). Drawing on more recent experience, countries with relatively rapid rates of currency depreciation following the breakup of the Bretton Woods System had relatively high rates of inflation. For example, Sweden's currency depreciated by an average of 5 percent per year between 1973 and 1985 against the deutsche mark, and its annual inflation rate was on the order of 4 percentage points higher than German inflation over the same period. In addition, until the past decade, many countries in Latin America were plagued by a combination of chronically high inflation and exchange rate depreciation. For example, the Mexican peso depreciated by an average of 31 percent per year against the dollar between 1977 and 1995, while the Mexican inflation rate averaged about 30 percent per year higher than the U.S. inflation rate
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Impact of monetary policy on exchange rate Economics Assignment

Topic: Impact of monetary policy on exchange rate

Roll No. 34 Roll No. 59 Roll No.38 Roll No. 60

Submitted To: Prof. Pankaj Upadhya

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Measuring monetary policy shocks in France, Germany, Italy

Indias exchange rate policy: weighing the 52-53 trade-offs

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Consumer prices France Italy Germany 19 33 46 0 82 2 9 5 35 22 8 33 23 23 52 0 83 5 8 3 52 30 7 9 28 18 52 0 82 7 8 2 59 27 10 1

Impact of monetary policy on exchange rate

ECU exchange rate France Italy 16 7 46 29 11 1 24 62 9 4 43 43 10 2 22 64 16 5 75 2 4 3 46 45 9 2 21 65 10 4 82 1

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

Impact of monetary policy on exchange rate

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