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Effect of Monetary Policy on the Exchange-Rate of the Dollar

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Let us consider the effect of monetary policy on the exchange-rate value of the dollar. Determine the effect of expansionary monetary policy (an increase in the money supply) on each of the following. Then determine what effect the change in the variable listed will have on the demand or supply of the dollar in exchange-rate markets and, in turn, upon the exchange-rate value of the dollar itself.

1. Interest rates.

2. Income level.

3. Prices (price level).

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Solution Summary

This job explores the effect of monetary policy on the exchange-rate value of the dollar.

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When the central bank adopts expansionary monetary policy, i.e., increase the money supply by open market operation, lowering reserve ratio or bank rates, the money supply curve will shift out to the left. In the short run, then the market move along the money demand curve and the new equilibrium then arrives at a lower interest rate level.
However, ...

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