Scenario: Gizmovia The Republic of Gizmovia wants to maintain the exchange rate of its currency, the gizmo, at $0.50, but the current exchange rate for the gizmo is $0.40. If Gizmovia uses monetary policy to bring the exchange rate for the gizmo to $0.50, it should _____ interest rates by _____ the money supply.

Question

Quizplus · Accepted Answer

The Republic of Gizmovia wants to increase the exchange rate of its currency, which means it wants its currency to appreciate against foreign currencies. To achieve this, it can use contractionary monetary policy, which involves increasing interest rates and decreasing the money supply. By increasing interest rates, it becomes more attractive for foreign investors to hold the gizmo, which increases the foreign demand for it and causes its value to appreciate (i.e., the exchange rate to increase). By decreasing the money supply, it also reduces inflationary pressure, which can further support the appreciation of the gizmo. Therefore, choice D is the correct answer.

Scenario: Gizmovia the Republic of Gizmovia Wants to Maintain the Exchange