The monetary approach predicts that an increase in the money supply by 12 percen

Question

The monetary approach predicts that an increase in the money supply by 12 percent in both China and Thailand will:

result in an appreciation of the Thai baht against the Yuan.

result in a depreciation of the Thai baht against the Yuan.

have no effect on the baht per Yuan exchange rate.

lower the volume of trade between Thailand and China.

A.

result in an appreciation of the Thai baht against the Yuan.

B.

result in a depreciation of the Thai baht against the Yuan.

C.

have no effect on the baht per Yuan exchange rate.

D.

lower the volume of trade between Thailand and China.

Explanation / Answer

have no effect on the baht per Yuan exchange rate.

We can then discuss the effects on the exchange rate of a change in domestic monetary policy. Suppose that, the domestic money supply is increased (via an open market operation) form MS1 to MS2. Then, the equilibrium in the money market requires a fall in the equilibrium domestic interest rate from the original i1 ) to i2 . In fact, at the original (pre-shock) level of the exchange, the fall in the domestic interest rate lead initially to a lower return on domestic asset relative to foreign assets. The ensuing capital outflow causes the depreciation of the domestic currency. In summary, a monetary expansion that leads to a reduction in domestic interest rates causes a depreciation of the domestic currency

Since we have considered only one country it is the case., when the same thing happens in both countries the effects are nullified by each other.

C.

have no effect on the baht per Yuan exchange rate.

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