Hi everyone I’ve got 2 related questions hope you can help thanks in advance!
The schweser text states that for high capital mobility countries: “Expansionary fiscal policy will also increase economic activity (growth) and inflation, leading to deterioration of the current account and a decrease in the demand for the domestic currency”.
Why is it that economic growth and inflation adversely affects the current account?
Also the text states that for low capital mobility countries: “…expansionary fiscal or mentary policy leads to increases in net imports”.
I can understand how fiscal policy would lead to more imports due to increased spending. How would monetary policy increase net imports?
Under low capital movility, exchange rates are not much affected by the level of interest rates (as it occurs under high capital movility), but rather by the sell/buy of goods and services (trade balance) between countries. An expansionary fiscal policy tends to increase national imports reducing the trade account (also the current account). Note that when you import goods from abroad you use foreign currency and hence the quantity of foreign currency in the domestic country becomes lower making the domestic currency to depreciate (lower demand on the domestic currency). An expansionary fiscal policy increases demand and hence inflation.
Be careful, expansionary fiscal policy increases imports, so decreases net imports.
Under low capital movility, again, the goods and services flow will determine the movement of exchange rates.
If it is an expansionary monetary policy, the more money in pocket will tend the people to spend in goods from abroad (more imports) and make the domestic currency to depreciate.
If it is an contractionary monetary policy, people has less money in pocket, so imports decrease and net imports increase. As less foreign currency flows out the country because imports decreased, the domestic currency appreaciates.
Was asking question 1 with regards to high capital mobility rather than low capital mobility
The Schweser textbook indeed states that is is a net increase and not decrease, that’s why is it confusing. I’m not sure if it is a typo? Can someone verify perhaps?
So high capital mobility - Expansionary monetary/ Retrictive or Expanionary fiscal --> currency depreciation??? Low capital mobility - Expansionary or restrictive monetary/Restrictive fiscal --> Currency appreciation? ??
Uncertain exactly means that outcome (appreciation or depreciation) depends on other factors specific for certain country.
Countries with limited capital inflows/outflows may establish monetary/fiscal policy with level of autonomy in the short term (in the long term these limits may cause limited growth).
Small economy monetary authorities (mostly in emerging countries) may have sufficient amount of foreign currency reserves so may defend local currency exchange rate at least in the short term. Monetary authorites in big countries cannot defend exch. rate by selling currency reserves or buying own currency simply because such reserves should be in extremly large amount. So mostly monetary and fiscal authorities in developed and big countries use different approcahes in FX rate direction compared to small or/and developing economy authorities.
Fiscal policy: No tax on dividend, no tax on capital gains, big infrastructural projects (highways construction)
Monetary policy: Ultra restrictive with several levels of penalty for banking credit activity over certain level
Result: strong local currency appreciation, moderate high growth, stock market and RE market bubbles with growth over 60 % annualy, rapidly increase of debt share in GDP.
Correct. When you will be asked just start thinking about real situation and in recent history there are many situations or this is not even history, these are current global econ issues.
When you mentioned Australia, just remember that Ossie will start rapid appreciate whenever Aluminium (iron oyre) turn in rapidly positive up trend. This may be an example of Dutch desease.