Imagine that the economy is at a point that is above both AA and DD, where both the output and asset markets are out of equilibrium. Which first action is TRUE?
A) The economy will stay at this level in the short run.
B) The exchange rate will first drop to a point on the AA schedule.
C) The exchange rate will first move to a point on the DD schedule.
D) The AA-DD equilibrium will shift to the position of the economy.
E) The exchange rate will first move left to a position on the AA schedule.

Question

Quizplus · Accepted Answer

The exchange rate will first drop to a point on the AA schedule because the asset market adjusts more quickly than the goods market, bringing the exchange rate to equilibrium in the asset market first.

Imagine That the Economy Is at a Point That Is