Assume that policy makers are pursuing a fixed exchange rate regime and that output is initially greater than the natural level of output. The economy will tend to move toward the natural level of output when which of the following occur?
A) An increase in the foreign price level.
B) A decrease in the domestic interest rate.
C) A devaluation of the currency.
D) An increase in the price level.
E) An increase in money supply.

Question

Quizplus · Accepted Answer

An increase in the price level will reduce real money balances, leading to higher interest rates and reduced investment and consumption, which will decrease output back towards the natural level.

Assume That Policy Makers Are Pursuing a Fixed Exchange Rate