Question

Under a flexible exchange rate system if the Reserve Bank eases monetary policy, this will increase:

Select one:

a. the demand for Australian dollars and cause it to depreciate

b. supply the of Australian dollars and cause it to appreciate

c. net exports

d. the demand for Australian dollars and cause it to appreciate

Answer 1

If the reserve Bank eases the monetary policy, i.e. increases the money supply, it will decrease the interest rate. When interest rate decreases, foreign investors will reduce their investment in Australian market because they will get less return on their investment. It will decrease demand for Australian dollar and as a result, Australian dollar will depreciate.

When the value of Australian dollar decreases, foreigners will find Australian goods much cheaper as compared to before because now they have to pay less of their Currency to get 1 AUD. Therefore, foreigners will demand more of Australian goods. Australia's export will increase. But Australian Consumers will now find foreign goods much costlier than before. Therefore, they will demand less of foreign goods. This will decrease Australia's import. Increase in export and decrease in import will increase Australia's net export (net export = export - import).

Answer: option C