CFA Level I · CFA Level I Exam · Monetary Policy
A central bank cuts its policy rate. Through the exchange rate channel of the monetary transmission mechanism, the cut would most likely lead to:
A policy rate cut most likely causes the currency to depreciate because domestic assets yield less. Imports become more expensive, which pushes inflation up, while exports become cheaper to foreigners. The appreciation option and the lower export demand option reverse these effects.
- Acurrency depreciation, which raises import prices and tends to increase inflationCorrect
- Bcurrency appreciation, which lowers import prices and tends to reduce net exports
- Ccurrency depreciation, which lowers export demand and tends to reduce inflation
Explanation
A lower policy rate reduces returns on domestic assets, lowering demand for the currency and causing depreciation. Imports become costlier, which adds to inflation, and exports become more competitive. The other options reverse the direction of the currency move or the effect on exports.
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