Question

Under a flexible exchange rate, a surge in capital inflow will result in:

A) A rise in foreign exchange reserves

B) An expansion in domestic money supply

C) A rise in net exports and domestic output

D) All of the above

E) None of the above

Answer 1

Under flexible exchange rate, the exchange rates float freely based on demand and supply of the currency.

• A surge in capital inflow will result in increase in the forex reserve because foreign currency will pour, so option A is correct
• When more money comes in, it is made available to the borrowers and businesses to borrow and if comes into the circulation, so this results in an expansion of the domestic money supply. So option B is correct
• More investment leads to increase in production and therefore it results in an increase in the exports as the increased production is also exported. So option C is incorrect.
• This implies that all of the above options are correct and which make option D correct.

This also implies option E is incorrect.