Question

1)

A)

Discuss the ineffectiveness of monetary policy while trying to correct a sluggish economy under a fixed exchange rate.

B)

if policy makers are particularly concerned about the current account deficit (i.e. trade deficit),

c) discuss whether stimulatory fiscal policy or monetary policy would make more sense while correcting recessionary gaps

Answer 1

*Answer:

In case of a fixed exchange rate, the exchange rate fluctuations due to change in money supply in the economy are to be neutralized by injecting or withdrawing an equal amount of foreign exchange in the system. This is done in order to control and maintain the exchange rate at its stipulated value. Therefore, monetary policy can't have any effect under a system of fixed exchange rates. It can only be effective when the exchange rates are allowed to freely float.

If the policy makers are concerned about the fiscal deficit in the economy under a fixed exchange rate, they must use fiscal policy for correcting recessionary gaps since monetary policy is ineffective. They need to cut government expenditure and increase  taxes so as to improve the fiscal balance.

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