The monetary model of a floating exchange rate predicts that the domestic currency will depreciate when any of the following occurs (more than one possible answer)Group of answer choicesDomestic money stock decreasesForeign money stock decreasesDomestic national income fallsForeign price level rises
Question
The monetary model of a floating exchange rate predicts that the domestic currency will depreciate when any of the following occurs (more than one possible answer)Group of answer choicesDomestic money stock decreasesForeign money stock decreasesDomestic national income fallsForeign price level rises
Solution
The monetary model of a floating exchange rate predicts that the domestic currency will depreciate when:
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Domestic money stock increases: When the domestic money supply increases, it leads to inflation. This means that the value of the domestic currency decreases, leading to depreciation.
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Foreign money stock decreases: When the foreign money supply decreases, it leads to deflation in the foreign country. This means that the value of the foreign currency increases relative to the domestic currency, leading to depreciation of the domestic currency.
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Domestic national income falls: When the domestic national income falls, it means that the country's economy is not doing well. This leads to a decrease in the value of the domestic currency, leading to depreciation.
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Foreign price level rises: When the foreign price level rises, it means that the foreign currency is worth more. This leads to a decrease in the value of the domestic currency, leading to depreciation.
Similar Questions
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Suppose that the annual growth rate of nominal money supply is 1% in New Zealand and 5% in the Australia, and the annual growth rate of real GDP is 2% in New Zealand and 4% in Australia. According to the monetary model of exchange rate, the New Zealand dollar would __________ against the Australian dollar on an annual basis in the long run.[Hint: See question 4 of In-class Quiz - Week 5A]Group of answer choicesappreciate by 2%depreciate by 2%appreciate by 4%depreciate by 4%
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