Foundations of Finance and Investment Essay Example | Topics and Well Written Essays - 1500 words

Foundations of Finance and Investment - Essay Example This paper would go to analyse the Impact on UK exchange rate against US$ over last five years due to recent MPC's 1 cut on interest rate. The pragmatic correlation among money, real output and interest rates has been attributed significantly with business cycle, monetary transmission mechanism, aggregate money demand and identification of monetary policy rules. There is no accords of interest rate to which should be included as an empirical models for exchange rate To providing the analyse the interdependency of Interest rate and Exchange rate, Fisher definition would not be relevant to economic analysis. So this paper would follow Keynes and other post-Keynesians notion of real rate and exchange rate. Smithin, J. (2003) mentioned that regulating interest rates for exchange rate cannot guard the purchasing power and it is quite unfeasible to do at the macroeconomic level. There is an empirical evidence of the break in the relationship between interest rates, exchange rate and inflation ever since 1953. The present analysis of UK interest rate cut and impact on US$ are relevant to specifying the monetary policy system pursued by the two monetary authorities. This paper assumes that the monetary authority regulates the short-term ostensible interest rate. According to classical Taylor theory the instrument is set to act in response to domestic inflation as well as output gap. On the other hand in open-economy model specificities more controversial reasoning the set of variables in the direction of which monetary policy can react is superior. The present strategy is to discover the consequences for the equilibrium allotment of simple rules, which lead to equilibrium that can be worked out analytically to understanding the transmission mechanism under open economies. The analyse go with three regimes and label as: - a) a fixed exchange rate; b) a floating exchange rate c) a managed exchange rate, Theoretical Aspect of Interest Rate First level let consider the rules that establish a fixed nominal exchange rate. Pigeon, M. A. (2004) added that it would demonstrate that in principle numerous fixed exchange rate regimes subsist on the specification of the fundamental rules. Thus a floating regime that is defined as a command in which the interest rates in both countries don't respond explicitly to the exchange rate. It would be characterised as where & is non-negative; here its combination of rules as floating command . These rules have been broadly used in the closed-economy literature. Most of the policymaker reacts to precedent movements in the interest rate, present household producer inflation rate and output gap. According to classical Taylor rules, the coefficients and are zeros.2 Benigno, G, & Benigno, P. (2006) argued within the floating-exchange regime, we consider also rules in which the reaction is toward the domestic