Question

consider an economy that abides by a mundell fleming model. Capital is imperfectly mobile, prices are perfectly sticky in the short run, and the exchange rate is fixed. Assume the current exchange rate is at its target and the current domestic interest rate is equal ot the foreign interest rate. Suppose the local central bank wants to stimulate economic activity by increasing the supply of money through conventional open market operations. Which of the following (domestic and foreign) policies would assist the domestic central bank in achieving its goal?

A. A foreign central bank increases the supply of its currency on the FX market (supply of Fx goes up) and domestic government spending rises.

B. Foreigners stop purchasing domestic exports (x falls) and domestic government spending falls.

C.The foreign price level falls

D. A foreign central bank raises its local interest rates (foreign investment goes up)

Answer 1

A is correct

When foreign central bank increases the supply of currency its income increases and increase in government spending leads to increase in aggregate demand that boosts the economy