1,a. Assume a country is in a fixed exchange rate regime such as China. Explain

Question

1,a. Assume a country is in a fixed exchange rate regime such as China. Explain what factors might cause individuals to expect that a country will revalue its currency. Explain the various actions that policy makers can choose in response to this expected revaluation.

b. Assume a country is in a fixed exchange rate regime. Now suppose that individuals expect that policy makers will devalue its currency. Explain the various actions that policy makers can choose in response to this expected devaluation.

c. Suppose the economy is operating below the natural level of output. Discuss the arguments for and against using devaluation in such a situation.

d. Suppose the economy is initially operating above the natural level of output. In a fixed exchange rate regime, explain how the economy will adjust to this situation.

Explanation / Answer

hanging monetary policy has important effects on aggregate demand, and thus on both output and prices. There are a number of ways in which policy actions get transmitted to the real economy (Ireland, 2008).

The one people traditionally focus on is the interest rate channel. If the central bank tightens, for example, borrowing costs rise, consumers are less likely to buy things they would normally finance

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