13. Use the money mad FX market to answer the following question about the relat

Question

13. Use the money mad FX market to answer the following question about the relationship between the British pound () and the U.S. dollar (S). The exchange rate is in U.S. dollars per British pound, Es/. Assume the United States temporarily expands its money supply, how does the exchange rate change in the short-run and in the long-run? (a) The exchange rate decreases (the dollar appreciates) in the short-run and remains (b) The exchange rate decreases (the dollar appreciates) in the short-run and goes back (c) The exchange rate increases (the dollar depreciates) in the short-run and goes back (d) The exchange rate increases (the dollar depreciates) in the short-run and remain at that level in the long-run to its initial level in the long-run to its initial level in the long-run. at that level in the long-run

Explanation / Answer

So, here let’s assume that “US” be the home country and “British” is the foreign country. So, in the SR price in both the country are fixed. So, if the money supply changes, => the rate of interest rate will change. So, in the SR the “exchange rate” will be determined by the “UIP” condition given below.

=> iH = iF + d, where “d” be the expected depreciation of home currency and “iH” and “IF” are the home and foreign rate of return respectively.

So, if the home money supply increases implied the “US real money balance” increases, => the home rate of return decreases given the money demand. So, according to the “UIP” as “iH” decreases implied to maintained the above identity “d” must decrease given the value of “iF”, => “d” will decrease if “E” will increase. So, in the SR as the “US” money supply increases implied the exchange rate will increase.

Now, in the LR price in both the country become flexible, => price will adjust to clear the money market in both the economy. So, in the LR price start adjusting, => the home rate of return come back to its initial position, => the nominal exchange rate also come to its initial position.

So, if the “US” money supply increases temporarily, => in the SR the exchange rate will increase but in the LR it goes back to its initial position.

So, here “C” be the correct option.

Related Questions

Navigate

• Browse (All)
• Browse 1
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.