Hi, In Schewser 2009 Practice Exam Volume 2 Exam 1 afternoon session question 76, the answer says an expansionary monetary policy will lower vlaue of dollar. This discourages imports and make U.S. goods more competitive in the international market. So, the current account moves towards surplus. However, in the CFA text book, it argues the expansionary monetary policy would cause rapid economic growth and accelearte inflation. Hence, it causes current account moves towards deficit. It seems the answer in question 76 conflict with what mentioned in the CFA text book. I am not sure if I miss anything. I appreciate if anyone can help me solve the puzzle.
The effect of expansionary monetary policy can be broken down into Interest Rate effect and Price Effect Interest Rate Effect Expansionary policy will increase monetary supply, which lowers the interest rate. Declining interest rate reduces foreign demand for domestic currency, which causes the domestic currency to depreciate. Depreciating currency strengthens exports and leads to an increase in current account. Price Effect Expansionary policy lowers the interest rate, which causes inflation and causes price to go up. Higher price level reduces foreign demand for domestic goods and hurts exports. As the result, current account deteriorates. Economists theorize that interest rate effect occurs immediately and price effect occurs in the long run. In summary, when you implement expansionary monetary policy, your current account improves temporarily due to higher money supply and depreciating domestic currency, but this increase would eventually reverse as the price effect and inflation kicks in. Hope it helps. Feel free to correct me if I messed up somewhere.
Came across that same question yesterday and had the same reaction as yours. also, in the solution Schweser says both of these are correct: “Statement 1: an expansionary monetary policy = a lower value of the dollar, which discourages imports” “Statement 2: an expansionary fiscal policy = higher economic growth which will encourage imports” I don’t see how both of those statements can be correct
See if this helps; trust me, our group has brought this up several times… Statement 1 is true because: Expansionary monetary policy with shift the supply of money to the right which will lower your interest rate. Lower int. rate will depreciate the currency, which makes foreign goods more expensive thus discouraging imports. Statement 2 is true because: Expansionary fiscal policy will lead to higher budget deficits but an increase in aggregate demand (I believe) which will lead to higher inflation and also lead to an increase in real rates. An increase in the real rate will help the currency appreciate, which will encourage imports.
well-said, $tarving_Banker.
$tarving_Banker’s answer was complete, but keep in mind it’s not the CFA answer. The current account decreases under both fiscal and monetary unexpected expansion (CFA must be looking at the long-term effect).