In the short run,a permanent increase in the domestic money supply
A)has stronger effects on the exchange rate and output than an equal temporary increase.
B)has stronger effects only on the exchange rate but not on output than an equal temporary increase.
C)has weaker effects on the exchange rate and output than an equal temporary increase.
D)has stronger effects on output,but lower effect the exchange rate than an equal temporary increase.
E)has weaker effects only on the exchange rate than an equal temporary increase.

Question

Quizplus · Accepted Answer

A permanent increase in the domestic money supply has stronger effects on the exchange rate and output than an equal temporary increase. This is because a permanent increase in the money supply leads to a sustained increase in demand for domestic goods and services, resulting in a higher output level in the long run. However, this sustained increase in demand also leads to higher inflation expectations, which puts downward pressure on the domestic currency's value in the foreign exchange market. In contrast, a temporary increase in the money supply has less impact on output as it only leads to a short-lived increase in demand, but it still affects the exchange rate through the inflation expectations channel. Therefore, a permanent increase in the money supply has stronger effects on both output and the exchange rate than an equal temporary increase.

In the Short Run,a Permanent Increase in the Domestic Money