Question

what would happen to a country's current account, capital account and financial account with central bank reducing the monetary policy rate

Answer 1

EFFECTS OF COUNTRY'S CURRENT ACCOUNT,CAPITAL ACCOUNT AND FINANCIAL ACCOUNT DUE TO CENTRAL BANK REDUCING THE MONETARY POLICY RATE

A central bank is a financial institution given privileged control over the production and distribution of money and credit for a nation or a group of nations. In modern economies, the central bank is usually responsible for the formulation of monetary policy and the regulation of member banks.As with the Fed system, the ownership of BoJ shares comes with caveats and restrictions. The government owns 55 percent of the central bank with the rest owned by private investors.A Central Bank is an integral part of the financial and economic system. They are usually owned by the government and given certain functions to fulfil. These include printing money, operating monetary policy, the lender of last resort and ensuring the stability of financial system.Examples of central banks include the Federal Reserve Bank (U.S.), the European Central Bank (EU) , the Bank of Japan (Japan) and the Reserve Bank of India (India).Central banks have several methods of controlling monetary policy, but the three most basic and widely used tools are short-term target rates, open market operations, and capital requirements.

Central banks conduct monetary policy by adjusting the supply of money, generally through open market operations. For instance, a central bank may reduce the amount of money by selling government bonds under a “sale and repurchase” agreement, thereby taking in money from commercial banks.Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.There are two main types of monetary policy:1)Contractionary monetary policy. This type of policy is used to decrease the amount of money circulating throughout the economy. 2) Expansionary monetary policy.

Central bank policy rate (CBPR)

The central bank policy rate (CBPR) is the rate that is used by central bank to implement or signal its monetary policy stance. It is most commonly set by the central banks policy making committees (e.g. Fed Open Market Committee).The underlying financial instrument of the CBPR varies per country and is explained in the metadata. For instance, in some countries the CBPR is the discount rate while in others it is a repurchase agreement rate.Central banks tend to focus on one “policy rate”—generally a short-term, often overnight, rate that banks charge one another to borrow funds. When the central bank puts money into the system by buying or borrowing securities, colloquially called loosening policy, the rate declines.

Current Accounts effects

Central banks such as the Reserve Bank of India influence monetary policy in the shifts in this crucial interest rate have a drastic effect on consumer tasked with maintaining a certain level of stability within the country's financial system  under its control is the ability to increase or decrease the discount rate.A current account deficit occurs when the value of imports (of goods/services/inv. incomes) is greater than the value of exports. Policies to reduce a current account deficit involve:

1. Devaluation of exchange rate (make exports cheaper – imports more expensive)
2. Reduce domestic consumption and spending on imports (e.g. tight fiscal policy/higher taxes)
3. Supply side policies to improve the competitiveness of domestic industry and exports.

The main issue with using monetary policy to reduce a current account deficit is that an increase in interest rates will tend to cause hot money flows and therefore an appreciation in the exchange rate. This appreciation makes exports less competitive, and imports more attractive. Assuming demand is relatively elastic, this appreciation will worsen the current account.Therefore, monetary policy has two conflicting effects.

1. Higher interest rates reduce spending on imports – improving the current account.
2. But, on the other hand, higher interest rates cause an appreciation in the exchange rate – worsening the current account.

• The overall effect is uncertain – it depends on which effect is bigger.
• higher interest rates will tend to cause a reduction in AD and improve the current account significantly.
• It depends on many other factors, for example, if the economy is growing strongly, a rise in interest rates may not actually reduce consumer spending – because income growth is high and confidence high.

Capital Account effects

The capital account is a record of the inflows and outflows of capital that directly affect a nation's foreign assets and liabilities. It is concerned with all international trade transactions between citizens of one country and those in other countries.The capital account is part of a country's balance of payments. It measures financial transactions that affect a country's future income, production, or savings. An example is a foreigner's purchase of a India's copyright to a song, book, or film. Its value is based on what it will produce in the future.

Monetary policy changes can have a significant impact on every capital account · Join a game conversely, when the economy is sluggish, the central bank will adopt an accommodative policy by lowering short-term interest rates to mortgage-backed securities directly from financial institutions.Monetary policy now affects the economy more through inflation expectations , exchange rate movements may decrease in the  economic growth accompanied by low inflation and low current account Is the effect of monetary policy on the productive capacity of the economy long lived? Yes, in fact we find notably, the capital stock and total factor productivity (TFP), GDP, current account balances, and nominal exchange rates to the home economy, and reduces the pass-through to home interest rates, all else equal.

Financial Account effects

Financial account is a component of a country's balance of payments that covers claims on or liabilities to nonresidents, specifically with regard to financial assets. Financial account components include direct investment, portfolio investment and reserve assets broken down by sector.The two types -- or methods -- of financial accounting are cash and accrual. Although they're distinct, both methods rely on the same conceptual framework of double-entry accounting to record, analyze and report transactional data at the end of a given period -- such as a month, quarter or fiscal year.

Reducing the interest rate from 8% to 6%. ... bank accounts and all other financial assets, something like money markets ... operations can lead to either expansionary or contractionary fiscal policy.Lower interest rates make the cost of borrowing cheaper. It will encourage consumers and firms to take out loans to finance greater spending and investment. Lower mortgage interest payments. A fall in interest rates will reduce the monthly cost of mortgage repayments.Lowering rates makes borrowing money cheaper. This encourages consumer and business spending and investment and can boost asset prices. Lowering rates, however, can also lead to problems such as inflation and liquidity traps, which undermines the effectiveness of low rates.

The period of low-interest rates makes investment financed by borrowing more attractive. With lower interest rates investment gives a relatively better rate of return because the cost of borrowing is low. At a low rate of investment, more projects will have a rate of return higher than the cost of borrowing.

These are the brief explanations about the reducing of central bank monetary policy rate effects upon the current accounts,capital account and financial account of the country.