Question

Please, don't just copy paste other people's answers. Please explain as much as you can so I can undertand. Thank you!!

Section 1: Recall the Monetary Model from last week. Describe the movement of each line in the context of what’s happening in the economy.

3: Suppose a country with a fixed exchange rate attempted to fix their rate at too strong a level. Analyze what effect this would have using the monetary model. What reasons may a country have to decide to do this?

Answer 1

If exchange rate is fixed too high, monetary policy can't be used because money expansion will lead to decline in exchange rate. In absence of domestic increase in money supply, foriegn money will flow in. This will lead to large bop disequilibrium. Ultimately govt may have to reduce exchange rate to correct Bop deficits. The deficit occurs because exports fall as they become expensive for foriegners and imports rise as they become cheaper.

There are many reasons like to improve terms of trade. Some developing countries set it too high so that imports of capital equipment which can not be produced locally can be cheap.