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Explain the process of adjustment

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Assume that an economy is operating at a high level of activity (economic boom) and a tight monetary policy is implemented to slow it down. Explain the process of adjustment in the economy under a:
a) a flexible exchange rate system
b) a fixed exchange rate system

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Solution Summary

The rise in interest rate is assessed.

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A tight monetary policy is implemented to slow the economy down. Such policy will lower the money supply and raise the interest rate.
The higher interest rate will discourage investment and consumer demand. Hence AD will shift to the left ...

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