In the monetary small open-economy model,a flexible exchange rate insulates the domestic price level from
A) both real and nominal shocks from abroad.
B) real shocks from abroad, but not from nominal shocks from abroad.
C) nominal shocks from abroad, but not from real shocks from abroad.
D) neither real nor nominal shocks from abroad.

Question

Quizplus · Accepted Answer

A flexible exchange rate allows the domestic economy to adjust to nominal shocks from abroad by changing the exchange rate, thus insulating the domestic price level. However, it does not insulate against real shocks, which affect the real economy and require adjustments in output or employment.

In the Monetary Small Open-Economy Model,a Flexible Exchange Rate Insulates