Assuming the free flow of capital across borders, which of the following statements is most correct?
A) A central bank can have both a fixed exchange rate and an independent inflation policy.
B) A central bank cannot have both a fixed exchange rate and an independent inflation policy.
C) The central banks of most industrialized countries focus on fixed exchange rates.
D) While most central banks of industrialized countries favor fixing exchange rates, their primary concern is on domestic inflation.

Question

Quizplus · Accepted Answer

If capital is free to move across borders, maintaining a fixed exchange rate would require a central bank to adjust its interest rates in line with those of the country to which its currency is pegged. This would limit the central bank's ability to pursue an independent inflation policy, as its interest rates would have to follow the country to which its currency is pegged. Therefore, a central bank cannot have both a fixed exchange rate and an independent inflation policy in a world of free capital movement.

Assuming the Free Flow of Capital Across Borders, Which of the Following