Economics beginners often find it difficult to understand what tightening and expansionary monetary policies are and why they have an impact. Generally speaking, contractionary monetary policy and expansionary monetary policy involve changing a country’s money supply level. Expansionary monetary policy is only a policy of expanding (increasing) money supply, while contractionary monetary policy reduces (reducing) a country’s money supply. In the United States, when the Federal Open Market Commission wants to increase the money supply, it can do a combination of three things: buying securities in the open market, known as open market operations, which directly affect interest rates. When the Federal Reserve buys securities in the open market, it causes the prices of these securities to rise. In my article on reducing dividend tax, we see that bond prices are inversely proportional to interest rates. The federal discount rate is an interest rate, so lowering it is essentially lowering interest rates. If the Fed decides to reduce the reserve requirement ratio, it will lead to an increase in the amount of money banks can invest. This leads to higher prices for investments such as bonds, so interest rates must fall. Whatever tools the Fed uses to expand the money supply, interest rates will fall and bond prices will rise. Rising US bond prices will have an impact on the foreign exchange market. Rising U.S. Treasury bond prices will prompt investors to sell these bonds in exchange for other bonds, such as Canadian bonds. Therefore, investors will sell his American bonds, exchange his dollars for Canadian dollars, and then buy Canadian bonds. This increases the supply of US dollars in the foreign exchange market, while the supply of Canadian dollars in the foreign exchange market decreases. As I pointed out in my Exchange Rate Guide, this makes the dollar less valuable than the Canadian dollar. Lower exchange rates make goods produced by the United States cheaper in Canada, while goods produced by Canada in the United States are more expensive, so exports will increase and imports will decrease, leading to an increase in trade balances. When interest rates are low, capital account financing costs are low. So everything else is equal, and lower interest rates lead to higher investment rates.