Conflicting Objectives

Fiscal & Monetary Policy

Unit 15 - Lesson 4

Effect of Fixed and Floating Exchange Rates

Balance of Payment:
The Balance is closely connected to exchange rates.
Everything recorded in the Balance of Payments creates a
supply/demand of domestic currency. (Credits & Debits)
Balance of Payments means there is a balance between the supply
for and demand for a currency. (Credits = Debits)

Conflicting Objectives in an Open Economy

Government objectives of price stability, full employment, and
economic growth - (3 main Macroeconomic Objectives)
When a country trades it has the additional responsibility
of maintaining a reasonable Balance of Payments and
preventing sharp fluctuations in its currency.
Pursuing a policy to correct one problem can at times
lead to problems elsewhere.

Expansionary Fiscal Policy

Domestically:
Expansionary Fiscal Policy financed by borrowing - higher interest rates can crowd out Private Investment - weakening (crowding out) the
expansionary effect of Government Spending.
Open Economy & Trade
Higher Interest Rates - Increased Investment from Abroad - Appreciating
the Currency - lowers exports - increases imports - also weakens the
expansionary effects of increased Government Spending.

Monetary Policy & Trade Balance

Expansionary Monetary Policy - Increases the Supply of Money - lowers
interest rates - depreciates the domestic currency - increasing exports decreasing imports.
Does this help or hurt a country? Depends on the Trade Balance
Expansionary Monetary Policy
Trade Deficit - Improves (helps) due to an increase in exports
Trade Surplus - Worsens (hurts) due to a increase in exports

Monetary Policy
Contractionary Policy - can be used to lower inflation - decreases the
supply of money - increases interest rate - decreases AD - Currency
Appreciates - Exports decrease - Imports increase.
This affects the Trade Balance.
Trade Deficit - Worsens (hurts) due to the increase in Imports
Trade Surplus - Strengthens (helps) due to a decrease in Exports

Currency Speculation
If a country believes that speculators are expecting the currency to
depreciate, the Central Bank and Government can:
Increase Interest Rates - Currency becomes more attractive Appreciating the Currency
However, if the economy is in a recession this could make the recession
worse - further Decreasing Aggregate Demand