When there is an increase in the demand for the Dong; the market exchange rate strengthens and the exchange rate moves to the lower end of the established band, the Authority sells VND to banks.
The money base (supply) will increase, pushing down Vietnamese dollar interest rates. Lower domestic interest rates relative to foreign interest rates restrain capital inflows into the nation (encouraging outflows).
Supply of foreign currency decreases, weakening the currency to restore stability.
External Balance r M s0 M D M 0 r 0 M p AD 0 Y 0 p 0 RGDP AS D FX0 Quantity Exchange rate e 0 S AUD0
Easy Money: Authority announces its decision to reduce interest rates – it buys government securities to maintain the lower interest rates; expanding the money supply and reducing the cost of credit. (Purchases)
Tight Money: Authority announces its decision to increase interest rates – it sells government securities to maintain the higher interest rates; reducing the money supply and increasing the cost of credit. (Sale)
Internal Balance – Contractionary Policy A policy aimed at increasing interest rates and to restrict AD D AUD0 Quantity Exchange rate S AUD e 0 Q 0 r M 0 M s0 M D r 1 r 0 M p Y 0 p 0 RGDP AS AD 0
Internal Balance – Expansionary Policy Policy aimed at reducing interest rates and raising the level of AD. Quantity Exchange rate e 0 Q 0 D AUD0 r M s0 M D M 0 r 0 M p AD 0 Y 0 p 0 RGDP AS S AUD0
Responsiveness of capital flows, consumption and investment to changes to changes in interest rates.
Phase of the business cycle.
Private decisions of lenders and borrowers.
Size of the expenditure multiplier.
Application Question 11 Suppose you are the monetary policy adviser for the government. The economy is experiencing a large and prolonged inflationary trend. What change in open market operations would you recommend?