Monetary Theory Exam Questions 2021
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faithmutune339Monetary Theory Exam Questions 2021
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Powered by AIFinancial intermediaries contribute to economic development by facilitating credit allocation, mobilizing savings, reducing information asymmetries, providing risk management services, and offering payment systems. By efficiently channeling funds between savers and borrowers, they enhance investment and consumption activities, supporting economic growth .
Deficit monetization occurs when a government finances its deficit by creating more money, usually through central bank purchases of government bonds. It is controversial because while it can help finance government spending without immediate tax increases, it risks leading to inflation if the increase in money supply is not matched by economic growth. It can also undermine central bank independence and long-term economic stability .
Excess reserves are bank reserves held beyond the required minimum, while required reserves are a mandatory portion of deposits banks must hold. Excess reserves can be influenced by interest rates set by the central bank, which influence the money supply's responsiveness to changes in economic conditions. They are critical in monetary policy as they determine the banking system's lending capacity and influence interest rate settings .
High interest rates in a developing economy can reduce investment by increasing borrowing costs, dampen consumer spending, appreciate local currency lowering export competitiveness, increase government debt service burden, and lead to capital inflows which may not align with productive investment needs, thus potentially slowing economic growth .
Monetary theory explains money's role in the economy through its impact on variables such as inflation, interest rates, and economic output. It considers the supply and demand for money, and how these affect the economy's aggregate demand and price levels, influencing economic stability and growth. The theory also examines how central banks use monetary policy to regulate money supply and control economic variables .
Fisher's Equation of Exchange, MV=PT, assumes that velocity (V) and the money supply (M) are stable, and that prices (P) are flexible. These assumptions are crucial to maintaining a stable relationship where money supply changes proportionally affect the nominal value of economic transactions (T), ensuring predictability in policy implications .
Currency depreciation can be caused by a decrease in interest rates, rising inflation, political instability, or lower foreign investment. Consequences include increased export competitiveness, higher import costs, and potential inflation as domestic prices adjust to more expensive imports, which can affect trade balances and economic growth .
The Phillips Curve illustrates an inverse relationship between unemployment and inflation, suggesting that as unemployment decreases, inflation tends to increase, and vice versa. This is based on the observation that lower unemployment increases wage pressure, leading to higher prices. However, this relationship can break down in the long term if expectations adjust or during periods of stagflation .
Central banks maintain a sound financial system by setting and implementing monetary policy, supervising and regulating financial institutions, acting as a lender of last resort, ensuring payment system reliability, and maintaining financial stability through tools like open market operations, discount rates, and reserve requirements to manage liquidity and control inflation .
Monetary policies in developing countries are often less effective due to factors such as underdeveloped financial markets, high levels of informal sector activity, weak institutional frameworks, limited central bank independence, and external volatility impacting currency stability. These factors reduce the impact of traditional policy tools on the economy .