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In: Economics

Using the diagram that represents an equilibrium in the asset market, as used in chapter 15...

  1. Using the diagram that represents an equilibrium in the asset market, as used in chapter 15 and 18, graphically illustrate how the home (US) central bank will respond to an increase in the foreign money supply (euro), if exchange rates are fixed. Make sure you identify which step goes first, second, etc. Label all diagrams. (10 points).

Solutions

Expert Solution

When demand for us dollars increase the supply of dollars will decrease and supply of foreign currency will increase as a result the money supply in the country will decrease, to counter such a situation US central bank can devalue the currency in order to curb the excess demand situation in the firex market under fixed exchange rate system.

First of all the demand for dollar rises and the stock of euro rises as a result demand curve shifts to the right causing an excess demand situation and shrinkage of money supply in the domestic US economy.
In order to restore equillibrium the central bank can devalue dollar under fixed exchange rate system to bring the excess demand situation under control.

Rahul Sunny answered 2 years ago
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