A country can operate a fixed exchange rate and practice independent monetary policy if and only if
A) it eliminates all tariffs
B) it targets a zero inflation rate
C) it imposes wage and price controls
D) it restricts inflows and outflows of financial capital
E) the central bank agrees to monetarize all fiscal deficits

Question

Quizplus · Accepted Answer

If a country wants to operate a fixed exchange rate and practice independent monetary policy, it needs to restrict the inflows and outflows of financial capital. This is because a fixed exchange rate requires maintaining a specific value for the currency, which would not be possible if the market was allowed to freely determine the exchange rate. However, if the country also wants to practice independent monetary policy, it needs to be able to adjust interest rates and money supply to manage its domestic economy. This requires controlling the flow of financial capital to prevent external factors from interfering with domestic monetary policy. Therefore, restricting financial flows is the only way to achieve both a fixed exchange rate and independent monetary policy.

A Country Can Operate a Fixed Exchange Rate and Practice