If the Deutsche Mark and the British pound exchange rates are fixed, and the German Bundesbank conducts a tight monetary policy to counteract an expansion in German GDP, interest rates in Germany will ____, which will force Britain to ______.
A) fall; default
B) rise; raise its rates to maintain interest parity and the fixed exchange rate
C) fall; sell gold
D) rise; lower its rates to maintain interest parity and the fixed exchange rate

Question

Quizplus · Accepted Answer

When the German Bundesbank conducts a tight monetary policy, it reduces the money supply, which typically leads to higher interest rates in Germany. To maintain interest parity and the fixed exchange rate with Germany, Britain would need to raise its interest rates as well.

If the Deutsche Mark and the British Pound Exchange Rates