According to Dornbusch's Overshooting Model, a monetary expansion will lead to: A. A depreciation of the domestic currency B. An appreciation of the domestic currency C. No change in the exchange rate D. A decrease in interest rates
Question
According to Dornbusch's Overshooting Model, a monetary expansion will lead to: A. A depreciation of the domestic currency B. An appreciation of the domestic currency C. No change in the exchange rate D. A decrease in interest rates
Solution
According to Dornbusch's Overshooting Model, a monetary expansion will lead to:
A. A depreciation of the domestic currency
This is because, in the short run, an increase in the money supply leads to a decrease in the domestic interest rate. This decrease in interest rate makes foreign investments more attractive, leading to a sell-off of the domestic currency, which in turn leads to its depreciation.
In the long run, the economy will return to equilibrium, but the exchange rate will "overshoot" its long-term equilibrium value, hence the name of the model.
So, the correct answer is A. A depreciation of the domestic currency.
Similar Questions
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The monetary model of a floating exchange rate predicts that the domestic currency will depreciate when any
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