Under fixed exchange rates, which one of the following statements is the MOST accurate?
A) Devaluation causes a decrease in output, a decrease in official reserves, and a contraction of the money supply.
B) Devaluation causes a rise in output, a rise in official reserves, and an expansion of the money supply.
C) Devaluation causes a rise in output and a rise in official reserves.
D) Devaluation causes a rise in output and an expansion of the money supply.
E) Devaluation causes a rise in official reserves, and an expansion of the money supply.

Question

Quizplus · Accepted Answer

Devaluation under a fixed exchange rate system makes domestic goods cheaper for foreigners and foreign goods more expensive for domestic consumers, which can increase exports and reduce imports, leading to a rise in output. The increase in demand for the domestic currency to purchase domestic goods increases official reserves. As the central bank acquires foreign currency, it typically increases the domestic money supply, leading to an expansion of the money supply.

Under Fixed Exchange Rates, Which One of the Following Statements