Monetary Policy International Finance and Exchange Rates

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82000 Macesich (2000) argues further that money plays a vital role in economic activities since it virtually makes the economic transaction possible. When the supply of cash is higher in the economy, consumers tend to have more money. This, in turn, encourages spending. On the other hand firms or businesses or ventures respond by increasing either raw materials or production. Because business activities tend to be spread, the demand for labor as well as capital goods increases. Increase in the expansion of money supply consequently results into increase in prices more so if the growth of output approaches the limited capacity. At this stage, consumers begin anticipating inflation. However, lenders begin aggravating for higher interest rates to balance the anticipated reduction in the purchasing power while offsetting the loans. The converse is true when money supply subsidizes or the growth rate declines. For an instant, Federal Reserve policy plays a crucial role in determining the money supply. It does so by influencing its deposits in the bank. They do this by mandating commercial banks to hold part of the deposits that they accept. These institutions comply by either holding cash in the vaults or holding deposits that they make at the Federal Reserve. The Federal Reserve, in turn, manipulates their reserve by lending cash to banks and changing the discount rate on loans. Therefore, when the supply of money in the economy is high, despite the interest rate target, the central banks tend to devise a mechanism that is aimed at limiting cash flow in the economy. When this is done, the demand for cash that is apparently at the bank reserves increases. This increase in the demand compels the central banks to stop holding money in the reserves. Central banks encounter a challenge of policy enforcement in the domestic banking system&nbsp.when there is liquidity surplus.&nbsp.Liquidity surplus hampers central banks from controlling targets deemed operational and the implication may be reflected in profitability.&nbsp.