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Monetary Policy ECON1311: Introduction to Macroeconomics Section: 203 Assignment 2: Monetary Policy Instructor’s name: Dr. Mahmood O. E. Hamad Due Date: 18th December, 2012 Done by: Reem Al-Nobi 201000178 Malak Al-Turki 201000194 Page 1 Monetary Policy Implementation The central bank sets a range of targets at different times, those targets includes short term interest rate, growth target for both narrow and broad money, inflation, exchange rate, the central bank study the effectiveness of their policy over time by theoretical models of the economy,” the riyal effectively pegged to the US dollar since the suspension of the SDR/riyal link in May 1981. In practice, this has resulted in riyal interest rates closely tracking dollar rates, often with a small premium, since the mid-1980s”( Al-Jasser, Banafe, 2012), this has led to limitation on the monetary policy of Saudi Arabia General description of the SAMA, managements, functions. SAMA the Saudi Arabia monetary agency, was established in 1952 based in Riyadh, and it is the central bank of the Kingdom Of Saudi Arabia which act as a banker to the government, issues the national currency, supervising commercial banks, manages law, regulations, finance and forging exchange reserves, “Conducts monetary policy for promoting price and exchange rate stability and promotes the growth and ensures the soundness of the financial system” (sama.gov.sa,2012), SAMA also operates a currency museum, that is located in Riyadh at the head office building. Since December 13, 2011 the convener of SAMA is Dr. Fahad AlMubarak, the vice convener is Dr. Abdulrahman A. AL-Hamidy since August 30, 2009. Banking system in Saudi Arabia The banking system of Saudi Arabia has developed to serve multifaceted economic, exchange, and regulatory roles in a way that suits the monetary policy of the country by SAMA that matches the Islamic view, which means the banking system can’t be a profitable institution, that don’t pay or receive interest, when SAMA was founded the commercial banks was in the hand of Saudi exchangers, nowadays “Twelve private commercial banks operated in the kingdom, providing full-service banking to individuals, and to private and public enterprises. Eight of the banks were totally Saudi-owned. Four were (countrystudies.us,2012). Page 2 joint ventures with foreign banks” Monetary Policy Money functions: Money is defined as any good that has a value and is commonly accepted and used by everyone to perform transactions. The four essential functions of money are that it serves as a medium of exchange, measurement of value, standard of deferred payments, and as a store of value. First of all, money serves as a medium of exchange as we provide it as a replacement of something else that we need and has the same value. Second, money is used as a measurement for the value of goods and services that we buy or sell. In fact, it became easy nowadays to determine the measurement of goods and services as money provides a language of economic communication (Sinha, 2012). Third, money is used as a standard of deferred payments as our purchases in the present are credited for the future, in other words “it’s used as a standard for specifying future payments for current purchases” (Economic glossary, 2012). Fourth, money must store its value in order to work as a medium of exchange. Since money is commonly accepted, it’s considered more liquid than other stores of value. In short, each one of these basic functions is important in a country’s economy and it makes everyday transactions much easier. Exchange rates and factors that influence the exchange rate: Exchange rate is defined as the current market price of one country’s currency when converted to another country’s currency. A country’s market economy is affected by exchange rates. Some factors that influence the exchange rate are: 1- Differentials to inflation: decreased inflation rate generates an increase in the currency value and purchase power, “Countries with low inflation rate is more likely to see an appreciation in their currency” (Economic.help, 2012). 2- Differentials to interest rates: High interest rates in a certain country are considered beneficial for you when thinking to deposit and save money in that country’s banks; the reason is that the higher interest rate provided by that country, the higher return you get from your savings. 3- Current account deficits: It shows that a county is importing more and exporting less goods and services (Amadeo, 2012). So the country is spending money on goods and services imported from other countries more than its receiving money from exporting. 4- Public debt: Exchange rates are sometimes affected by public debt. Public debt is determined by the transactions made by a country including its exports and imports. Page 3 Monetary Policy 5- Terms of trade: It’s a comparison between export prices to import prices measured in ratio. When a country’s terms of trade is less than 100%, it indicates that they have more capital going out than coming in. 6- Political stability and economic performance: Investors with big capitals always seek to find stable countries in terms of inflation and flow of currency as they are interested in the goods and services provided by that country. Relationship between the Dollar and the Saudi Riyal: The relationship between the dollar and the Saudi riyal in terms of exchange rate is that 1 Saudi riyal is equivalent to 3.75 dollars. There are some factors that relate the dollar and the Saudi riyal. The price of oil in Saudi Arabia is measured in dollars which indicates that exports of Saudi Arabia are also measured in dollars. In addition, the relationship between the dollar and Saudi riyal is positive in the long run which means both countries are benefited from this relationship (Alfawaz, 2012). Inflation in Saudi Arabia: Inflation is defined as the rate at which the prices of goods and services go high while the purchasing power falls down. Each country’s economy has a different rate of inflation depending on their market economic situation. Inflation rate of Saudi Arabia was recorded by SAMA at 3.90% in November 2012. To analyze the inflation rate since 2003 to 2012, SAMA has recorded the average rate within that period and found it to be 3.81%. The highest inflation rate recorded during that period was 11.08% in July 2008 and the lowest was 0% in September 2004 (Trading economics, 2012). Page 4 Monetary Policy Sources Alfawaz, F. (2012). Saudi riyal and quantitative easing. Riyadh, Arab News. Retrieved from: http://www.arabnews.com/saudi-riyal-and-quantitative-easing Amadeo, K. (2012). The U.S. Trade Deficits. Retrieved from: http://useconomy.about.com/od/tradepolicy/p/Trade_Deficit.htm Economic glossary. (2012). Economic definition of standard of deferred payment. Retrieved from: http://glossary.econguru.com/economic-term/standard+of+deferred+payment Economic.help. (2012). Factors which influence the exchange rate. Retrieved from: http://www.economicshelp.org/macroeconomics/exchangerate/factors-influencing.html Sinha, A. (2012). what are the important functions of money? Retrieved November 22, 2012, from preservearticles: http://www.preservearticles.com/201012271801/functions-of-money.html Trading economics. (2012). Saudi Arabia inflation rate. Retrieved from: http://www.tradingeconomics.com/saudi-arabia/inflation-cpi Al-Jasser,M. Banafe, A. (2012). Monetary policy instruments and procedures in Saudi Arabia. Retrieved from: http://www.bis.org/publ/plcy05j.pdf SAMA. (2012). About SAMA. Retrieved from: http://www.sama.gov.sa/sites/samaen/AboutSAMA/Pages/SAMAFunction.aspx Countrystudies. (2012).Money And Banking. Retrieved from: http://countrystudies.us/saudiarabia/44.htm Page 5