If the Fed reduces the money supply to reduce inflation, a floating exchange rate will aid the Fed in fighting inflation because

Question

Quizplus · Accepted Answer

When the Fed reduces the money supply, interest rates typically increase. With a floating exchange rate, this increase in interest rates leads to a strengthening of the exchange rate, which means that foreign goods become relatively cheaper compared to domestic goods. This causes the price of U.S. exports to rise and the price of U.S. imports to fall, making it easier for the Fed to fight inflation. This is why choice B is the correct answer.

If the Fed Reduces the Money Supply to Reduce Inflation