Question

When the currency of a country appreciates in the short run and then depreciates to its original level in the long run, it implies that the foreign money supply has:

Select one:

a. temporarily fallen.

b. temporarily risen.

c. permanently fallen.

d. permanently risen

Answer 1

We generally plot the exchange rate on the Y-axis and the quantity of domestic currency on the X-axis.

A currency appreciation in the short run would shift the money supply curve rightward and the domestic money supply will rise. There is an increase in the exchange rate. This would imply that the foreign money supply has risen.

However, in the long run, due to currency depreciation, the money supply will again show a backward trend and small fall in the foreign money supply can be observed.

Therefore, it can be concluded that the foreign money supply rises only for a temporary time.

Hence, option b. is correct