Why will govt buy domestic bonds and increase liquidity in market for country B
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If Govt will buy domestic bonds from the market, it will buy from investors. So basically they are handing the cash to these investors ultimately leading to liquidity in the hands of investors.
But why will they increase the liquidity when there is ample liquidity already there in the market – doesnt hot money flowing out mean foreign currency reserves falling leading to increase in supply of dometic currency ? I am not getting the logic .
Hot money flowing out means people are selling domestic assets which are leading to steep fall in the asset values, but by infusing liquidity in the hands of people the central bank is trying that the markets don’t fall that much.
if the central bank attempts to push
interest rates down (up), capital will flow out (in), putting downward (upward)
pressure on the exchange rate, forcing the bank to buy (sell) its own currency
and thereby reversing the expansionary (contractionary) policy.
Statement quoted from CFAI mock . Plz throw light on the significance of this statement w.r.t the question .