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perfect capital mobility

Consider a group of open economies; assume perfect capital mobility;
(a) Assume there is a Leader country. All other countries (referred to as the Follower countries) fix their exchange rates vis-à -vis the Leader country. Discuss the effectiveness of monetary policy in the Follower countries.
(b) If the Leader country reduces its money supply to fight inflation, what must the Follower countries do to maintain their fixed exchange rate? What is the effect on their economy? What would happen in the Follower countries if they did not change their money supply?

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(a) Assume there is a Leader country. All other countries (referred to as the Follower countries) fix their exchange rates vis-à -vis the Leader country. Discuss the effectiveness of monetary policy in the Follower countries.

Expansionary monetary policy in a follower country with pegged exchange rate regime has no effect in the exchange rate and output. The increase in M would lead to lower interest rates and, therefore, a more depreciated currency and higher output. However, the ...

Solution Summary

Expansionary monetary policy in a follower country with pegged exchange rate regime is examined.

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