Question

When exchange rates are fixed, a temporary expansion in the money supply will:

A. increase output.

B. leave output unchanged.

C. lower output.

D. increase the exchange rate.

Explain your answer. DO NOT COPY FROM COURSEHERO!

Answer 1

Option B leave output level unchanged

Explanation

Fixed exchange rate is a system in which the exchange rate is determined by government or authority.if there is Increase in money supply them in short run it will cause appreciation in Currency but in long run it has no impact on output level. When money supply Increase, interest rate falls and Fed will come forward and intervene to maintain the equilibrium exchange rate by using it's policies and ultimately there will be no change in interest rate, income or exchange rate and output level . Hence, monetary policy becomes ineffective as a policy tool in fixed exchange rate system.