Effect of Restrictive Monetary Policy and Fiscal Policy
Hi all,
Just see this question somewhere else. You definitely can answer. But can you do it in 1.5min as what you are supposed to do in the exam?
Monetary Policy Fiscal Policy
a) Capital account surplus Currency appreciation
b) Currency appreciation Capital account deficit
c) Capital account deficit Currency depreciation
d) Currency depreciation Capital account surplus
i got a perfect score in economics and i don’t know the answer :D
msaadkamal, I am sure you know the answer if you go over what you have learned one more time. However, in the exam, I suggest everyone thinking by following this chain:
change of policy => effect on REAL interest rate and inflation => effect of exports and imports => effect of balance of payment
And also starts with monetary policy.
With a restrictive monetary policy, it means there are less money circulating. Therefore, less inflation. REAL interest rate also increases because of less money to borrow. So, US dollar appreciate! Therefore, more import and less export. And therefore currency account become more deficit. If US dollar appreciates, it attracts more foreign investment and more US bonds can be sold. Therefore, capital account is more surplus.
So, only a and b can be the answer.
And remember, fiscal policy almost always has opposite effects to the monetary policy (at least in CFA exam). So, for restrictive fiscal policy, a) is wrong.
Therefore the answer is b). Of course, you should check if capital account will be more in deficit for restrictive fiscal policy if you have time. But if you only have 1.5min, go with it!
More about the exchange system can be found here:
http://minute-class.com/finance/exchange-systems/
Also note, monetary and fiscal policies only go in the same direction for inflation. But inflation is in the long run. Therefore, we should consider real interest rate, and how interest rate affects the balance of payments