Under a floating exchange rate regime, an increase in money demand will lead to a) an...

Under a floating exchange rate regime, an increase in money demand will lead to

a) an increase in output that is larger than would be under a fixed exchange rate regime

b) a decline in output that is smaller than would be under a fixed exchange rate regime

c) an increase in output that is smaller than would be under a fixed exchange rate regime

d) a decline in output that is larger than would be under a fixed exchange rate regime

Solutions

Expert Solution

Option d

d) a decline in output that is larger than would be under a fixed exchange rate regime

Increase in money demand shifts the money demand curve to the right and increases the interest rate

Effect of it under a fixed exchange rate regime:

1) The increase in interest rate decreases investment and consumption spending and shifts AD curve to the left which decreases output and price level in the economy.

2) The increase in interest rate increases foreign investment in the country, but the exchange rate is fixed so the currency will not appreciate immediately and import will be as it is.

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Effect of it under flexible exchange rate regime:

1) The increase in interest rate decreases investment and consumption spending and shifts AD curve to the left which decreases output and price level in the economy.

2) The increase in interest rate increases foreign investment in the country, so the exchange rate increases and the import from country decreases means net export decreases which decreases AD and decrease output.

So the more output decreases under a flexible exchange rate system.

Rahul Sunny answered 1 year ago

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