In an open economy under flexible exchange rates, contractionary monetary policy in the short run will always cause:
A) an increase in the interest rate.
B) a decrease in output.
C) an increase in the exchange rate.
D) All of the above.
E) Both B and C.

Question

Quizplus · Accepted Answer

Contractionary monetary policy typically leads to higher interest rates as the central bank reduces the money supply. Higher interest rates attract foreign capital, leading to an appreciation of the exchange rate. The higher interest rates also reduce investment and consumption, which leads to a decrease in output. Therefore, all of the effects listed are expected outcomes of contractionary monetary policy in the short run in an open economy under flexible exchange rates.

In an Open Economy Under Flexible Exchange Rates, Contractionary Monetary