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Impact of World Monetary Policy Changes in Sri Lanka

Impact of World Monetary Policy Changes in Sri Lanka

The U.S. Federal Reserve Bank (Fed) decreased interest rates for the first time since the Great Recession in 2008 by a quarter-percentage point on July 31, 2019. Hence, it implies that the Fed has lowered its target federal funding level from 2.25% – 2.50% to 2.00% – 2.25%.
The Fed achieves its target federal funds prices by open market operations involving its acquisition and sale of government securities in the free market. As announced, the Fed will buy government securities through open market operations to obtain a reduced national fund rate. Buying securities from the Fed injects cash into the banking system, increasing the number of reserve funds accessible to lend to banks. This rise in the supply of money puts downward pressure on the level of federal funds. Such central bank purchases of government securities are called expansionary monetary policy.
Expansionary monetary policy is causing declining borrowing expenses. In reality, other interest rates in the economy like prime lending rate, house loan rates, and car loan rates also tend to decrease when the federal funds rate decreases. It is anticipated that reduced borrowing costs will lead to more consumer and business activity and investment. The primary goal of such an expansionary monetary policy is this anticipated boost to the economy. Furthermore, monetary easing is used to attempt to ignite inflation when inflation is running very low.

Impact of World Monetary Policy Changes on Sri Lanka
Figure 1 Source: Central Bank of Sri Lanka (CBSL)

A decrease in interest rates could result in the dollar falling. The U.S. Dollar Index decreased from its peak on July 31 by 1.5 percent. The dollar is already on an upward trajectory for several years. The dollar’s trajectory will be affected by other key banks’ interest rate reductions and distinctions in development between the U.S. and the rest of the globe. Interest rate and growth differentials are unlikely to move a lot in the contemporary setting.
Most analysts, however, think that the dollar is unlikely to reinforce significantly. For Sri Lanka, this is excellent news. In 2018 the rupee of Sri Lanka came under tremendous pressure. The world is facing a macroeconomic and geopolitical climate that is increasingly difficult and complex. Slower economic growth and proper inflation will present more significant difficulties for central banks in monetary policy. In such a situation, Sri Lanka’s Central Bank should have its entire monetary policy toolbox at its disposal to cope flexibly and pragmatically with future macroeconomic uncertainties. It is not supposed to be dogmatic. The function of a Central Bank is ultimately to achieve macroeconomic stability in terms of price, foreign exchange, reserves and security of the financial system. It is a purely independent authority responsible for implementing policy regimes as per its supervisory and regulatory functions and while it is banker to the government and its agencies, considers the country’s fiscal hazards and significant macroeconomic imbalances in all decision-making.

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Article Code : VBS/AT/01102019/Z_T4

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