How can a large balance of payments surplus contribute to a country’s inflation rate?

Question 1: Monetary Policy (Illustrate your answers where possible)

I. If the central bank has an interest rate target, why would an increase in the demand for bank reserves lead to a rise in the money supply?
II. The benefits of central bank lending to banks (rediscount operations) to prevent bank panics are obvious. What are the costs?
III. Compare the use of open-market-operations, central bank lending facilities (rediscounting), and changes in reserve requirements to control the money supply on the following criteria: flexibility, reversibility, effectiveness, and speed of implementation.

Question 2. International Finance and the Exchange Rate (Illustrate your answers where possible)

I. How can a large balance of payments surplus contribute to a country’s inflation rate?
II. Why is it true that in a pure flexible exchange rate system, the foreign exchange market has no direct effects on the money supply? Does this mean that the foreign exchange market has no effect on monetary policy?
III. What are the main benefits and costs of monetary union? What are the main criteria for the optimality of a currency area?

 

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