In the macroeconomic model of the open economy developed in the text, if the central bank increases the money supply, the price level will:
A)rise, the real interest rate will rise, the nominal interest rate will rise, the real exchange rate will rise and the nominal exchange rate will rise
B)rise, the real interest rate will be unaffected, the nominal interest rate will rise, the real exchange rate will be unaffected and the nominal exchange rate will rise
C)rise, the real interest rate will be unaffected, the nominal interest rate will be unaffected, the real exchange rate will be unaffected and the nominal exchange rate will be unaffected
D)rise, the real interest rate will be unaffected, the nominal interest rate will rise, the real exchange rate will be unaffected and the nominal exchange rate will fall

Question

Quizplus · Accepted Answer

Increasing the money supply typically leads to inflation (a rise in the price level). This can lower real interest rates as nominal rates may not immediately adjust to reflect the higher inflation. However, in this scenario, it's stated that the nominal interest rate rises, which could be due to the central bank's policy stance or expectations of future inflation. The real exchange rate remains unaffected because it's influenced by relative prices and purchasing power, not directly by the money supply. The nominal exchange rate falls because a higher money supply usually devalues the currency in foreign exchange markets, making it cheaper in terms of foreign currencies.

In the Macroeconomic Model of the Open Economy Developed in the Text