Assume that policy makers are pursuing a fixed exchange rate regime and that the economy is initially operating at the natural level.Which of the following will occur as a result of a evaluation?
A)The real exchange rate will be permanently higher in the medium run.
B)The real exchange rate will be permanently lower in the medium run.
C)The effects of this devaluation on the real exchange rate will be ambiguous in the medium run.
D)The nominal exchange rate will initially increase in the short run and then decrease in the medium run.
E) none of the above

Question

Quizplus · Accepted Answer

In a fixed exchange rate regime, policymakers adjust monetary policy to maintain the exchange rate, so the effects on the real exchange rate from a devaluation are not straightforward and can be offset by policy actions. Additionally, the nominal exchange rate is fixed by definition, so it does not increase or decrease in response to market conditions in the short or medium run as implied by the other options.

Assume That Policy Makers Are Pursuing a Fixed Exchange Rate