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IAI Actuarial Core Principles · Business Economics · Impact of macroeconomic policies on businesses

A central bank raises its policy rate to curb inflation. Which combination of effects on a capital-intensive manufacturing firm and on the exchange rate is most consistent with standard monetary transmission, other things equal?

Raising the policy rate makes borrowing for investment more expensive and, by making domestic assets more attractive to foreign investors, tends to push the rupee up. So the firm faces higher financing costs together with upward pressure on the exchange rate.

  1. AHigher cost of financing investment, and upward pressure on the rupee as foreign capital is attractedCorrect
  2. BLower cost of financing investment, and downward pressure on the rupee
  3. CHigher cost of financing investment, and downward pressure on the rupee as capital leaves
  4. DNo change in financing cost, and upward pressure on the rupee
  5. Lower cost of financing investment, and upward pressure on the rupee

Explanation

A higher policy rate raises borrowing costs and so discourages investment projects with long horizons. Higher domestic returns also attract foreign portfolio capital, raising demand for the rupee and pushing its value up. This hurts exporters' competitiveness, though it makes imported inputs cheaper.

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