This comes from reading 19 of Economics, factors influencing currency values. Why does an expansionary monetary policy cause the real interest rate to drop? Why the real rate and not the nominal rate? Thanks, HM
Because an expansionary monetary policy usually causes inflation which reduces the real rate but not the nominal rate. real rate = nominal rate - inflation Also an expansionary monetary policy in itself usually involves a reduction in the nominal rate by the authorities, reducing the real rate even further.
Almost pedpenny (1+Real) = (1+Nominal)/(1 + Inflation) shortcut Nominal - Inflation = Real Be sure to know the whole formula and not just the shortcut. Expansionary Monetary Police, logically, money will need to be cheap (low discount & fed funds rate) in order to encourage people and companies to borrow and grow.
I prefer to take shortcuts in life!
Haha, me too. But I have a feeling it won’t fly on a certain Saturday in June. Do you know for certain if we need to know both or just the easy one?
Not sure, I havnt even looked at level two economics yet, as it was one my strong points in Uni, but once you know the one you presented, I dont think remembering the other will be tough
It’s your last comment that explained it the best. Now with fiscal policy, the impact on real rate is the opposite. A govt that maintains tight fiscal policy tends to cause the real rate to go down, thus negatively impacting currency value. What’s the connection here? pedpenny Wrote: ------------------------------------------------------- > Because an expansionary monetary policy usually > causes inflation which reduces the real rate but > not the nominal rate. > > real rate = nominal rate - inflation > > Also an expansionary monetary policy in itself > usually involves a reduction in the nominal rate > by the authorities, reducing the real rate even > further.
Not too sure about this one, I would guess that a tight fiscal policy leads to a decrease in growth/aggregate demand, and therefore a reduction in spending by both the public and private sector, which leads to an increase in saving/decares in borrowing, and so the interest rate’s fall. Also possibly as the government is trying to rein in borrowing through its tight fiscal policy, may directly lead to a reduction in the real interest rate through less borrowing by the government.
Let me throw this out there. Monetary Policy = Fed = Discount Rate adjustment. Fed funds rate follows these policies as well. Fed controls interest rates. Fiscal Policy = Taxation. High taxes reduce consumption, low taxes encourage consumption overall. These two parties remain independent allowing for checks and balances within our economic infrastructure. I think Ped hit it right, I’m having a hard time seeing fiscal policy influence interest rates.
Ya its based on the IS LM model, it reduces consumption and therefore the IS curve shifts in, which leads to a fall in interest rates, its a keynesian view on things. But as Quantjock said it probably doesnt have any influence on interest rates in reality
Here’s another possible explanation. Lose fiscal policy is associated with increased govt. debt, which in turn causes nominal interest rates to rise (crowding out theory). If nominal rates rise and inflation expectations remain in check, the real rate should increase also.
The opposite then would be tight fiscal poicy, whichs leads to a fall in nominal rate’s, through the crowding in effect on the private sector