A monetary expansion in a flexible exchange rate regime will cause:
A) the IP curve to become horizontal.
B) an appreciation of the domestic currency.
C) no change in the exchange rate.
D) a downward shift of the IP curve.
E) a depreciation of the domestic currency.

Question

Quizplus · Accepted Answer

In a flexible exchange rate regime, an increase in the money supply leads to an increase in aggregate demand, which leads to higher prices and inflation. Higher inflation makes the domestic currency relatively less valuable, leading to a depreciation of the currency. This is because in a flexible exchange rate regime, the exchange rate adjusts to maintain equilibrium between the demand and supply of the currency. Therefore, the correct answer is E, a depreciation of the domestic currency.

A Monetary Expansion in a Flexible Exchange Rate Regime Will