Suppose policy makers are pursuing a policy to fix the exchange rate.In such a system with perfect capital mobility,an open market purchase of domestic bonds by the domestic central bank will eventually result in
A)a permanent increase in the monetary base.
B)a permanent reduction in the monetary base.
C)a change in the composition of the monetary base.
D)a gradual reduction in the domestic interest rate.

Question

Quizplus · Accepted Answer

In a fixed exchange rate system with perfect capital mobility, an open market purchase of domestic bonds increases the monetary base initially, but to maintain the fixed exchange rate, the central bank will have to sell foreign reserves, offsetting the initial increase and changing the composition of the monetary base.

Suppose Policy Makers Are Pursuing a Policy to Fix the Exchange