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Impact of fiscal and monetary policies on the exchange rate

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How changes in fiscal and monetary policies affect the exchange rate.

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How changes in fiscal and monetary policies affect the exchange rate?
Monetary policy works through changes in the money supply. Fiscal policy works through changes in government spending or taxes. An increase in money supply (i.e., expansionary monetary policy) lowers the home interest rate. As a result, the domestic currency depreciates. An increase in government spending, a cut in taxes, or some combination of the two (i.e. expansionary fiscal policy) raises output. The increase in output raises the transactions demand for real money holdings, which in turn increases the home interest rate. As a result, the domestic currency appreciates.

Monetary Policy is where the central bank of a country influences the money supply. Monetary policy primarily influences asset markets (Money market and Foreign Exchange market). An expansionary monetary policy means that the Central Bank has increased the money supply. An expansionary monetary policy leads to a decline in domestic interest rates. This is because interest rate is the price for using money. The more is the supply of money, the lesser is the price paid for using this money. As domestic interest rates ...

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Multi choice problems about exchange rates

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1. An increase in real income in Canada should:
2. McCain Foods (Canada) buys $50 million of Japanese securities. This transaction causes the Canadian:
3. Other things equal, a reduction in Canadian interest rates relative to foreign interest rates should:
4. If the government chooses a particular exchange rate and offers to buy and sell currencies at that rate, it has a:
5. Floating exchange rates:

Refer to Figure 4.1 as you answer question 6.

6. To maintain the price of francs at $.40 the government must:
7. The current Canadian exchange rate system is most like a:
8. A country that imposes a tariff will reduce its:

Refer to Figure 4.2 as you answer question 9.

9. Suppose the initial supply and demand curves are S and D when a tariff is imposed. The tariff will cause:
10. Many economists oppose trade restrictions because of:
11. When the value of the Canadian dollar fell in the 1990s, this:
12. Which of the following statements best describes the relationship between exchange rates and aggregate demand for Canadian output?
13. A weak dollar would be the best policy if the government wanted to:
14. A country that wants to fix its exchange rate at a higher level than the market exchange rate would most likely adopt:
15. In 1992, Germany adopted a tight monetary policy to reduce its inflation rate. Britain and Italy, whose currencies were effectively fixed to the German mark, let their currencies depreciate against the mark rather than intervene to preserve the fixed rate with the mark. The most likely reason for this decision was that defence of the pound and lire:
16. Monetary policy affects exchange rates in all the following ways except through its impact on:
17. As the price level increases, the trade balance:
18. In the short run, the net effect of expansionary monetary policy tends to:
19. The net effect of an expansionary fiscal policy is:
20. The basic idea of crowding out is that a budget:
21. Canadian fiscal policy is most likely to shift the demand for dollars from D1 to D2 if it increases Canadian:

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