Today, the RBNZ permanently rises in the level of the NZ money supply. In the long run, nominal interest rates in NZ _______. In New Zealand, today's spot exchange rate ________ the expected future exchange rate.Group of answer choicesremains unchanged; rises by a larger magnitude thanfalls; rises by a larger magnitude thanrises; falls by a larger magnitude thanremains unchanged; falls by a larger magnitude than
Question
Today, the RBNZ permanently rises in the level of the NZ money supply. In the long run, nominal interest rates in NZ _______. In New Zealand, today's spot exchange rate ________ the expected future exchange rate.Group of answer choicesremains unchanged; rises by a larger magnitude thanfalls; rises by a larger magnitude thanrises; falls by a larger magnitude thanremains unchanged; falls by a larger magnitude than
Solution
The answer is "remains unchanged; falls by a larger magnitude than".
Here's the step-by-step reasoning:
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In the long run, according to the Quantity Theory of Money, an increase in the money supply leads to an equivalent increase in the price level, assuming that real output and the velocity of money are constant. This means that the real value of money decreases, but the nominal interest rate remains unchanged because it is determined by the supply and demand for money, which are not affected by changes in the money supply in the long run.
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Today's spot exchange rate is determined by the current supply and demand for different currencies. If the RBNZ increases the money supply, this increases the supply of NZ dollars, which should lead to a depreciation of the NZ dollar (i.e., a rise in the exchange rate, which means that it takes more NZ dollars to buy one unit of foreign currency).
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However, the expected future exchange rate is determined by expectations about future economic conditions. If the increase in the money supply is expected to lead to higher inflation in the future, this could lead to an expectation of further depreciation of the NZ dollar in the future. This means that today's spot exchange rate falls by a larger magnitude than the expected future exchange rate.
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Therefore, in the long run, nominal interest rates in NZ remain unchanged, and today's spot exchange rate falls by a larger magnitude than the expected future exchange rate.
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