External Stability (1 Viewer)

[pomsky]

How does the monetary policy influence external stability?

 

[Ekman]

Monetary policy can also change the interest rates via domestic market operations. These changes can influence investment patterns. For example, an increase in interest rates will cause an increase in foreign investment, resulting in a surplus in the KAFA due to capital inflow, and a deficit in the CA in the mid term due to the repayments made on that investment. Hence the monetary policy can influence investor patterns as well as level of national savings, which influences the level of foreign liabilities as it impacts decisions made by the private sector about borrowing funds overseas or domestically.

Also the monetary policy can influence the value of the AUD, by either changing the interest rates, dirtying the float or jawboning. These influences on the AUD can influence the investor confidence as an appreciated currency will deteriorate investor confidence due to the increased risk, but an appreciating currency will still continue to have investment flows. On the other hand, a depreciated currency will increase investment flows due to the lower risks, but a depreciating currency will indicate that the economy is undergoing a recession and deteriorate investor confidence.