State in brief aboput the Monetary Effects

Besides real income effects there will also be monetary effects if nations seek to intervene in foreign exchange markets which government do to influence value of their exchange rate. This is done by either buying or selling foreign exchange. However, as foreign exchange constitutes part of a country's high powered money supply this affects the quantity of money in the economy. If the country has less than fully flexible exchange rates this provides another linkage between countries. If a country is expanding its domestic money supply which results in an increase in its imports. This will improve the balance of payments of the foreign countries with whom it is trading. In the absence of exchange rate intervention the value of the foreign currency may appreciate against the country's currency.

If this is viewed as undesirable the overseas government will sell its own currency and buy the country's currency on foreign exchange markets. The effect will be that the foreign country will go on accumulating the country's currency. The result will be an expansion in its level of high powered money. This is turn will lead to a multiple expansion in that country's own money supply. Clearly, domestic monetary policy affects aggregate demand and economic welfare in other countries. Only if exchange rates are completely flexible will there be no monetary effects.