With floating exchange rates, the effects of international trade shocks on internal balance are _____ by the effects of the resulting change in the _____.
A)not mitigated; LM curve.
B)not mitigated; exchange rate.
C)mitigated; LM curve.
D)mitigated; exchange rate.

Question

Quizplus · Accepted Answer

With floating exchange rates, the effects of international trade shocks on internal balance are mitigated by the effects of the resulting change in the exchange rate. This is because a change in the exchange rate can affect relative prices, making exports cheaper and imports more expensive, which can help to offset the initial shocks to internal balance. The LM curve is not directly affected by changes in the exchange rate, so A and C are incorrect.

With Floating Exchange Rates, the Effects of International Trade Shocks