Question

To what extent can monetary policy be used to affect output in a fixed exchange rate regime? Explain.

Answer 1

You give up on an independent monetary policy, with a fixed exchange rate. Monetary policy can not be used to target domestic inflation or to try to smooth the domestic business cycle.
Capital controls are measures that prohibit traders from buying or selling domestic currency, but capital controls limit trade and foreign direct investment and create incentives for corruption

The only hope for independent monetary policy is exchange controls to prevent traders from buying or selling domestic currency, but exchange controls reduce trade and foreign direct investment and present opposition

In a fixed exchange regime, a monetary policy has no influence on GNP or the exchange rate. As such, trade equilibrium, unemployment and interest rates all remain the same. Monetary policy becomes ineffective as a policy tool in a fixed exchange rate system.