A country with a fixed exchange rate faces:
A) no monetary policy constraints in the long run.
B) no monetary policy constraints in the short run.
C) no monetary policy constraints in the long run and the short run.
D) monetary policy constraints in the long run and the short run.

Question

Quizplus · Accepted Answer

A country with a fixed exchange rate has to maintain the exchange rate pegged to a foreign currency. This means that the country's central bank must have enough foreign currency reserves to intervene in the foreign exchange market to buy or sell the domestic currency in order to maintain the exchange rate target. As a result, the central bank is constrained in its ability to pursue independent monetary policies, as it must adjust its domestic interest rates to match those of the country to which its currency is pegged. This constraint applies in both the short and long run, making option D the correct answer.

A Country with a Fixed Exchange Rate Faces