Suppose policy makers are pursuing a policy to fix the exchange rate. In such a system with perfect capital mobility, an open market sale of domestic bonds by the domestic central bank will eventually result in:
A) a change in the composition of the monetary base.
B) a permanent increase in the monetary base.
C) a gradual decrease in the domestic interest rate.
D) a gradual increase in the domestic interest rate.
E) a permanent decrease in the monetary base.

Question

Quizplus · Accepted Answer

An open market sale of domestic bonds by the central bank reduces the monetary base, but in a fixed exchange rate system with perfect capital mobility, the central bank must intervene to maintain the exchange rate, which changes the composition of the monetary base without permanently altering its size.

Suppose Policy Makers Are Pursuing a Policy to Fix the Exchange