International Macroeconomics question, only need to answer question (c) and in d

Question

International Macroeconomics question, only need to answer question (c) and in detail please, thanks.

(a) The recovery of output after the Financial Crisis was the slowest ever observed in UK history. Many economists believe that this was due to the measures of austerity introduced by the government to reduce debt. George Osborne, the Chancellor of the Exchequer at the time, described the plan with which public debt should be reduced while at the same time stabilising output in the following way: Monetary activism to keep interest rates low and stimulate the economy. Fiscal respon- sibility i.e., fiscal contraction] to restore confidence and rebuild our battered public hnances Use the IS-LM-FX model to explain Osborne's plan. Contrary to Osborne's expectations, the 40 marks economy was not stabilised, but contracted. Can you explain why? (b) The measures of austerity were primarily introduced because of the government's fear that the high level of government debt could result in a debt crisis akin to Greece. Is this likely to have (30 marks) happened without austerity? Discuss (c) In the current low-interest rate environment, the Bank of England has implemented a number of unconventional monetary policy measures (e.g., quantitative easing). Is predicting how the exchange rate behaves as the result of unconventional monetary expansion more or less difficult than after a conventional monetary expansion? Discuss 30 marks

Explanation / Answer

After the financial crisis of late 2000 followed by a deep economic recession central banks of different countries were forced to adapt unconventional monetary policy measures to foster economic growth.

Central bank of England also implemented lower interest rates & range of unconventional monetary policy including quantitate easing. The Chancellor of the Exchequer authorized the BoE to set up an Asset Purchase Facility (APF) to buy high-quality assets financed by the issue of Treasury bills and the DMO’s cash management operations. QE supported financial & banking industry by providing abundant access to central bank liquidity & lowering the cost of debt.

In quantitate easing Bank of England made large purchase of assets. These included assets from private sector as well as government bonds. This asset purchase program or quantitate easing has substantial effects on exchange rates. In normal economic conditions central banks’ balance sheet & forecasts do not change much, but QE creates a significant change in central bank balance sheet as well as other financial institutions.

Since unconventional monetary policy improves money supply in financial system, makes borrowing easy & low interest environment boost investments it is difficult to predict how the currency price will be affected. The response of forex market is not predictable. So it’s difficult to predict the exchange rate behavior than a conventional monetary expansion.

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