Under fixed exchange rates, which one of the following statements is the MOST accurate?
A) Devaluation causes a reduction of the money supply.
B) Devaluation has no effect on the stock of money.
C) Devaluation causes an expansion of the money supply.
D) Devaluation causes a reduction in output.
E) Devaluation causes a reduction in official reserves.

Question

Quizplus · Accepted Answer

Under fixed exchange rates, devaluation causes an expansion of the money supply. This is because devaluation leads to an increase in the domestic currency value of exports and a decrease in the domestic currency value of imports, which in turn leads to an increase in the demand for domestic currency. In order to meet this increased demand, the central bank must increase the supply of domestic currency, which leads to an expansion in the money supply.

Under Fixed Exchange Rates, Which One of the Following Statements