Consider an outside shock on the value of the dollar that causes it to depreciate. The Fed could defend the dollar by
A) increasing the money supply thereby lowering the LM curve and driving the interest rate up.
B) increasing government spending thereby raising the IS curve and driving the interest rate up.
C) reducing the money supply thereby raising the LM curve and driving the interest rate up.
D) increasing taxes thereby lowering the IS curve and driving the interest rate down.
E) simultaneously increasing government spending and the money supply so that GDP climbs with a fixed interest rate.

Question

Quizplus · Accepted Answer

C) Reducing the money supply would raise the LM curve, leading to higher interest rates. Higher interest rates would attract foreign capital, appreciating the dollar and defending its value.

Consider an Outside Shock on the Value of the Dollar