In the Mundell-Fleming model with fixed exchange rates, attempts by the central bank to decrease the money supply:
A) lead to a lower equilibrium level of income.
B) lead to a higher equilibrium level of income.
C) must be abandoned in order to maintain the fixed exchange rate.
D) must be offset by expansionary fiscal policy.

Question

Quizplus · Accepted Answer

In the Mundell-Fleming model with fixed exchange rates, if a central bank attempts to decrease the money supply, it would lead to an appreciation of the domestic currency. However, to maintain the fixed exchange rate, the central bank must intervene in the foreign exchange market by buying domestic currency and selling foreign currency, which effectively negates the initial attempt to decrease the money supply.

In the Mundell-Fleming Model with Fixed Exchange Rates, Attempts by the Central