When a country's central bank temporarily switches from an expansionary to a more conservative monetary policy, one would expect the exchange rate to:
A) depreciate in the short run, then return to its initial value.
B) appreciate in the short run, then return to its initial value.
C) depreciate in the short run and then stay higher.
D) appreciate in the short run and then stay lower.

Question

Quizplus · Accepted Answer

When a central bank adopts a more conservative (or contractionary) monetary policy, it typically increases interest rates or takes measures that reduce the supply of money in the economy. This makes the currency more attractive to foreign investors due to higher returns on investments denominated in that currency, leading to an appreciation of the currency in the short run. Over time, as the economy adjusts, the exchange rate may return to its initial value depending on various factors including adjustments in interest rates, inflation, and economic growth.

When a Country's Central Bank Temporarily Switches from an Expansionary