Expansionary Monetary/Fiscal Policy

Is my thinking on this correct? Expansionary Monetary Policy = Increase Money Supply = Decrease Interest Rates = Depreciation of Domestic Currency = Move toward current account surplus (or lower deficit) because less importing, more exporting = Move toward capital account deficit (or smaller surplus) because less investing in the country (due to lower rates) Expansionary Fiscal Policy = lower taxes = increased business activity, demand for currency = increased interest rates, currency appreciation = Capital account surplus, current account deficit (for the opposite reasons of above)

(Unexpected) Expansionary Monetary Policy: - Current Account Deficit - Financial Account Deficit —> DEPRECIATING currency (Unexpected) Expansionary Fiscal Policy: - Current Account Deficit - Finanancial Account SURPLUS —> Mixed; Short-run the currency will appreciate, Long-run it will depreciate

How does Expansionary Monetary Policy lead to current account deficit? Where did I go wrong in my logic above?

Depreciation of currency = fewer imports, more exports (all else equal) = Current acct surplus, no?

I know the answer and looked up a page number for your reference. That’s as deep as my knowledge for econ is going: Schweser: Study Session 4, Reading 19, p.85

Ok I checked it out. I’m not really happy with that answer, since it seems to ignore the offsetting effect of the depreciating currency on the country’s citizens’ ability to import. To increase imports to further increase a deficit (or shrink a surplus) would require a lot more purchases given the depreciating currency (due to the lower real interest rate). Seems like it is a mixed result. Page 580-81 of CFAI vol 1 says that the real interest rate drops, increasing inflation, which leads to depreciation o f the domestic currency. If that doesn’t occur, the current account would go to deficit. If both Current AND Financial go into deficit (e.g. move in same direction), then what has to happen to the official reserve? Huge increase?

boost Wrote: ------------------------------------------------------- > Ok I checked it out. I’m not really happy with > that answer, since it seems to ignore the > offsetting effect of the depreciating currency on > the country’s citizens’ ability to import. > > To increase imports to further increase a deficit > (or shrink a surplus) would require a lot more > purchases given the depreciating currency (due to > the lower real interest rate). > > Seems like it is a mixed result. > > Page 580-81 of CFAI vol 1 says that the real > interest rate drops, increasing inflation, which > leads to depreciation o f the domestic currency. > If that doesn’t occur, the current account would > go to deficit. > > If both Current AND Financial go into deficit > (e.g. move in same direction), then what has to > happen to the official reserve? Huge increase? Yes, but there’s a limit to that since they’re holdings of official reserves are limited. After that point, they’re gonna have to just let the currency free fall. Just remember, all the accounts have to balance to 0.

Not sure if this is correct. But i think it has to do with the capital account being more mobile than the current account.

What do you think of this: Expansionary Monetary Policy increases business activity immediately, increasing imports over exports in the short run (leading to immediate current account deficit), which, combined with decrease in real interest rates, leads to depreciation of currency in long term (current account surplus). That seems to make everything fit.

It’s called a J Curve effect.

i dont have it in front of me now but i recall secret sauce and schweser conflicting on the effects of fiscal and monetary policy expansion, particularly in the current account area.

i don’t think that’s exactly what the j curve is. j curve is the resulting pattern of the trade balance when a currency depreciates (assuming you’re starting at a current account surplus). when the currency devalues, imports become more expensive, resulting in the net (exports - imports) figure decreasing (down part of the curve). however, the cheaper currency stimulates exports as they are cheaper abroad in the long run, thus putting more distance between exports and imports resulting in the up part of the curve. so i guess what i’m saying is that j curve isn’t when imports increase, it’s when they become more expensive due to the devalues currency.

i think beachbum is correct. restrictive fiscal policy leads to: 1. slower growth (decreases imports) --> currency appreciates 2. lower inflation (increases exports) --> currency appreciates 3. lower real interest rates (increases investments abroad) --> currency DEPRECIATES financial capital is more mobile, so the 3rd effect dominates. expansionary fiscal policy leads to currency appreciation in the short run due to larger deficits, but will cause the currency to depreciate over the long term if deficits persist. expansionary monetary policy leads to: 1. rapid economic growth (more demand for imports) 2. higher inflation (decreases exports) 3. lower real interest rates (increases investment abroad) all 3 factors will cause the currency to depreciate the opposite is true for restrictive monetary policy (currency appreciation)

I think its universally understood that the expansionary monetary policy depreciates the currency, I’m still unclear on its impact on the current and capital accounts, as indeed Schweser page 85 Book 2 says they are both in deficit yet the solutions page in Exam Volume 2, page 214 (q76) suggests the current account surpluses. As noted earlier in the chain, the CFA book on the topic didn’t clear this issue up. Hopefully they just ask about FX impacts and not account impacts. Still, anyone able to come up with a definitive answer re the direction of balances for capital and current accounts?

“indeed Schweser page 85 Book 2 says they are both in deficit yet the solutions page in Exam Volume 2, page 214 (q76) suggests the current account surpluses.” The errata say that they f-ed up. Currency decreases with monetary policy, although fiscal policy is mixed because the short term effect is appreciation, but long term effect is depreciation. The current accounts decrease for both fiscal and monetary, and the financial account is deficit for monetary and surplus for fiscal.