Which of the following is most likely to happen if the demand for money decreases in the domestic economy under floating exchange rates and free capital mobility?
A)The domestic interest rate will increase.
B)Domestic borrowing will decline.
C)The financial account of the country's balance of payments will deteriorate.
D)The average price level in the domestic economy will decrease.

Question

Quizplus · Accepted Answer

The financial account of the country's balance of payments will deteriorate.When the demand for money decreases, people will hold less money and more bonds. This will lead to a decrease in the demand for domestic bonds, which will cause the domestic interest rate to increase. The higher interest rate will attract foreign capital, which will lead to an appreciation of the domestic currency. The appreciation of the domestic currency will make domestic goods and services more expensive for foreigners, which will lead to a decrease in exports and an increase in imports. This will lead to a deterioration in the financial account of the country's balance of payments.

Which of the Following Is Most Likely to Happen If