In the monetary small open-economy model with a fixed exchange rate, a temporary decrease in domestic total factor productivity in the absence of any other shocks

Question

Quizplus · Accepted Answer

A temporary decrease in domestic total factor productivity in the absence of any other shocks would lead to a decrease in output and an increase in domestic prices, leading to a decrease in the demand for domestic goods and an increase in the demand for foreign goods. This would cause an increase in imports and a decrease in exports, leading to a decrease in the current account surplus. In response to this, the central bank would sell foreign currency to maintain the fixed exchange rate, leading to a decrease in the domestic money supply. Thus, choice D is the correct option.

In the Monetary Small Open-Economy Model with a Fixed Exchange