According to the Mundell-Fleming model with floating exchange rates, political uncertainty in Mexico in 1994 caused the risk premium on Mexican interest rates to ______ and the Mexican exchange rate to ______.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease

Question

Quizplus · Accepted Answer

According to the Mundell-Fleming model with floating exchange rates, an increase in political uncertainty leads to an increase in the risk premium on interest rates in that country. This means that investors demand a higher return to compensate for the increased risk. As a result, the interest rates in Mexico increased. In addition, an increase in political uncertainty leads to a decrease in demand for the country's currency, causing the exchange rate to depreciate. Therefore, the correct answer is B.

According to the Mundell-Fleming Model with Floating Exchange Rates, Political