Consider an economy with a fixed exchange rate and money supply equal to 2 billion pesos. The country has 1 billion in reserves and 1 billion in domestic credit. If the output in the country were to increase by 5%, then:
A) the money demand would increase by 10%.
B) the central bank would have to increase reserves by 5%.
C) the central bank would have to decrease reserves by 5%.
D) the central bank would have to decrease domestic credit.

Question

Quizplus · Accepted Answer

With an increase in output, the demand for money is likely to increase as businesses and consumers engage in more transactions. To maintain the fixed exchange rate while accommodating the increased demand for money, the central bank may need to increase its reserves, thereby injecting more money into the economy. This action helps to prevent the currency from appreciating, which would be inconsistent with maintaining a fixed exchange rate.

Consider an Economy with a Fixed Exchange Rate and Money