Answer to Question #283423 in Macroeconomics for Comfort

Question

QUESTION TWENTY

The Bank of Zambia’s monetary policy committee lowered its policy rate by 125 basis points to 8%

on 18th August responding to the growing COVID-19 crisis. Discuss what would happen to all the

necessary components of the Balance of Payment for Zambia. Please, explain clearly how this would

affect the exchange rate. [15 marks]

Answer 1

With an increase in interest rates, investment activity decreases, production and consumption of goods decrease, and imports decrease accordingly. The balance of payments will improve.

The lowering of interest rates, as the theory predicts, has the opposite effect: the growth of national production (due to the easing of credit conditions) and an increase in demand for national and foreign goods. The balance of payments will deteriorate.

Nevertheless, even in countries with comparable levels of development, an increase in the differential of interest rates does not always lead to an increase in the exchange rate of the national currency. For example, in the conditions of the development of the economic crisis, a decrease in the differential can lead to an increase in the exchange rate. The reason for this is the desire of investors during this period of the economic cycle not to multiply, but to preserve their own capital.

Thus, in order to understand the mechanism of the impact of the interest rate differential on the exchange rate, it is necessary to realize at what stage of the economic cycle the world economy is at. Thus, during a recession and recession, a decrease in interest rates may lead to an increase in the exchange rate of the national currency, and, conversely, in the conditions of recovery and recovery, an increase in the differential will contribute to an increase in its quotations.

However, it is impossible to say exactly what will happen to the exchange rate, since it is necessary to deeply analyze macroeconomic indicators such as inflation, unemployment, industrial production and many others.