What Is the Relationship Between Monetary Policy and Exchange Rates?

The goal of monetary policy is the ultimate goal of monetary policy adopted by a country's central bank or monetary authority. Including: economic growth, stable price levels, full employment, stable interest rates, stable exchange rates, and balance of payments. Although the central bank cannot directly bring about these situations, it can formulate different policies for the variables it can affect. There are often conflicts between the two objectives of monetary policy. Policy can achieve one goal, but it also makes the other goal more difficult to achieve. ^[1] The goal of China's monetary policy is to keep the currency stable and promote economic development.

Monetary policy goals

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The relationship between monetary policies is more complicated, and some are consistent, such as full employment and economic growth; others are relatively independent, such as full employment and balance of payments; more often, they are conflicting goals. The contradiction between the goals is as follows: there is an alternating relationship between price stability and full employment. To achieve the goal of full employment when there is too much unemployment, it is necessary to expand credit and increase the money supply in order to stimulate investment and consumer demand, expand production scale, and increase employment; meanwhile, the sharp increase in demand will bring Degree of price rise. Conversely, if monetary policy is to achieve price stability, it will also lead to a reduction in employment. Therefore, the central bank can only find an appropriate combination point between the price increase rate and the unemployment rate according to the specific socio-economic conditions.

There is also a contradiction between price stability and economic growth. To stimulate economic growth, the expansion of credit and currency issuance should be promoted, which will lead to rising prices; in order to prevent inflation, credit contraction measures must be taken, which will adversely affect economic growth.

There is a contradiction between price stability and the balance of payments. If inflation occurs in other countries and domestic prices are stable, the country s exports will increase, imports will decrease, and the balance of payments will be in a surplus; otherwise, a deficit will occur, which will worsen the balance of payments.

The contradiction between economic growth and balance of payments. With economic growth, the demand for imported goods will usually increase, resulting in a trade deficit; conversely, in order to eliminate the deficit and balance the international balance of payments, it is necessary to tighten credit and reduce the money supply, resulting in slower economic growth.

To sum up, due to the contradiction between the goals, the central bank should choose specific policy goals according to different situations.

In an open society, the balance of payments is closely related to the domestic money supply. During the surplus, the money supply tends to increase; during the deficit, the money supply will decrease. Therefore, the central bank must balance the balance of payments as much as possible.

For any one country, the above-mentioned goals often cannot be taken into account at the same time. The most obvious is that there are quite serious contradictions between price stabilization and full employment, and between economic growth and balance of payments. How to make appropriate choices among these conflicting goals is the biggest problem that central banks face when formulating monetary policies.

In China, the choice of monetary policy goals has two propositions in practice, one is a single goal, with stable currency value as the primary basic goal; the other is a dual goal, which is to stabilize the currency and develop the economy. Judging from the historical evolution of central bank monetary policies in various countries, whether it is a single goal, dual goal or multiple goals, it cannot be separated from the economic and social environment at that time and the most prominent basic contradiction at that time. However, monetary policy must maintain sufficient stability and continuity, and policy objectives must not be biased and changeable.

The relationship between the goals of monetary policy is a unified and contradictory relationship between the goals of monetary policy. In the long run, these goals are unified and mutually reinforcing: economic growth is the material basis of other goals; price stability is the prerequisite for stable economic growth and continuous growth; full employment means the full use of resources, and the enterprise More willing to invest in capital equipment to increase productivity, thereby promoting economic growth in a country; international balance of payments is conducive to domestic price stability, is conducive to the full use of international resources, thereby expanding domestic production capacity, promoting economic growth, and also beneficial to The stability of interest rates and exchange rates in the financial market; the stability of the financial market and the financial system can provide a good monetary and financial environment for domestic production and investment, ensure stable economic growth, promote high employment, enhance import and export capabilities, and promote balance of payments. balance. But in the short term, there are contradictions and conflicts between these goals.