Monetary Policy International Finance and the Exchange Rate

The central bank maintains an interest rate target in order to reduce or decrease the rate of inflation, improving the growth rate, stabilizing the financial market, and maintain the stability that is associated with the exchange rate and interest rate (Edwards, 2000). The increase in the demand for the bank reserves results in the increase in the money supply in the economy since the extent of openness in the economy results in the increase in the exchange rate in the economy and it results in the increase in the revenue from exports and maintaining of stability in the exchange rate. The interest rate by the central bank leads to stabilizing the economy for the achievement and attainment of the ultimate goal for stabilizing the economy as a whole (Mishkin, 2007).The decrease in the reserves affects the money supply in the economy and the change in the interest rate mainly affects the consumers and the businesses in changing the aggregate demand and therefore he borrowing activity is directly related to the change in the interest rate which influences or affects the economic activity and the growth rate of the Gross domestic product (Arnold, 2008).The central bank introduces the monetary base through which it can change the money supply and influence the circulation of currency and bank reserves in the economy which is mainly represented by the monetary base which is considered as the total of bank reserves and the currency in circulation in the economy (Mankiw, 2002).From the above diagram, it can be explained that as the money supply curve moves towards the right, the rate of interest rate decreases and the number of money increases by taking into consideration that he demand curve will not shift with the increase in the money supply from Ms1 to Ms2, the interest rate moves from r1 to r2 which indicates that the increase in the money supply decreases the interest rate in the market (Abel and Ben, 2005).

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