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Compose a 1000 words essay on In conditions of perfect capital mobility and a floating exchange rate, monetary policy may be effective in achieving both internal and external balance. Needs to be plag
Compose a 1000 words essay on In conditions of perfect capital mobility and a floating exchange rate, monetary policy may be effective in achieving both internal and external balance. Needs to be plagiarism free!
The capital market is perfectly elastic to the global capital market and capital is perfectly mobile. That implies the domestic rate of interest should be equal to the global interest rate. If there is any dispersion from the condition, that would cause a huge transfer of capital. For example if the domestic rate of interest exceeds global rate the global investors would find that investing in that country would secure higher return and hence that would be followed by a huge capital inflow and vice versa.
On the other hand the capital market of the domestic country is so small that it would not influence the global capital market.
In a floating exchange rate regime we cannot start our analysis from the simultaneous existence of internal and external disequilibrium as Balance of Payment is always balanced under a floating exchange rate regime. If there is any Balance of Payments disequilibrium (say deficit), the foreign exchange market and the product market play the role of automatic stabilizer. We consider a deficit. that implies an excess demand situation in the foreign exchange market. That is followed by the depreciation of domestic currency. While the domestic currency depreciates the domestic goods become cheaper in the global market and the foreign goods become dearer in the domestic market. That would result in an expenditure switching in favour of domestic product. (Marshall Lerner Condition is satisfied). Gradually the balance of trade would improve and finally the external balance would be achieved.
According to the Mundell Fleming Model the government should adopt an expansionary monetary policy in that time to solve the problems simultaneously. What would happen with that expansion of money supply? It is quite natural that expansionary monetary policy would cause a rise in money in the hand of the people more than they require (excess supply situation in money market). People would