With a contractionary monetary policy,as the output gap increases,the response of the central bank will tend to cause net capital outflows to ________ and cause the nominal exchange rate to ________.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease

Question

Quizplus · Accepted Answer

With a contractionary monetary policy, the central bank will raise interest rates to reduce inflation. This will make domestic assets relatively more attractive, causing capital to flow into the economy. As the output gap increases, the central bank will need to raise interest rates even further to cool the economy, which will cause net capital outflows. At the same time, a higher interest rate will strengthen the domestic currency, causing the nominal exchange rate to appreciate. Therefore, the best choice is C, which says that net capital outflows will decrease and the nominal exchange rate will increase.

With a Contractionary Monetary Policy,as the Output Gap Increases,the Response