Explain why the money supply could not be considered a polic

Explain why the money supply could not be considered a policy variable in an open- economy macro model under fixed exchange rates, but it can under floating exchange rates

Solution

Answer:

Assume that the country has settled conversion standard administration and is experiencing a subsidence. In such a case, an expansionary fiscal policy will increase GDP that will end the recession but it will raise interest rate, and so there might be increased capital inflows if capital is mobile. In that case, currency will appreciate. Additionally, higher GDP will bring about higher discretionary cash flow with the goal that imports are expanded in respect to trades. The last outcome is a cash appreciation.

Due to the commitment towards exchange rate, money supply has to be increased which results in inflation, reduction of interest rate and release of currency in the fore market. Currency depreciates and the exchange rate is restored to its fixed level. This would be resulting in maintaining both internal and external balance. In contrast, if only a monetary expansion would have done, the initial effect would be a currency depreciation as a result of inflation and this would have forced the central bank to follow a reversal of the policy to keep the exchange rate fixed.

Conclusion; when there is a fixed exchange rate regime so that the country fixes the value of its currency in terms of other currencies, the central bank attempts to show a commitment to maintain the value. In such a scenario, monetary policy has no effect. There is a complete loss of monetary authority autonomy. On the off chance that there is an adaptable conversion scale administration, there is no such responsibility thus fiscal specialist has full self-governance over cash supply and a money related extension isn\'t trailed by financial withdrawal.