When the exchange rate depreciates in the short run and then appreciates to its original level in the long run, it implies that the domestic money supply has:
A) temporarily risen.
B) permanently risen.
C) temporarily fallen.
D) permanently fallen.

Question

Quizplus · Accepted Answer

When the exchange rate depreciates in the short run and then appreciates to its original level in the long run, it implies that the domestic currency has temporarily lost value compared to foreign currencies. This means that it takes more of the domestic currency to buy foreign currencies. To counter this, the central bank may increase the domestic money supply temporarily, by buying government securities or other assets. This increases the supply of money and lowers interest rates, which can stimulate spending and boost the economy. However, in the long run, the exchange rate returns to its original level, indicating that the temporary increase in the money supply was not sustained.

When the Exchange Rate Depreciates in the Short Run and Then