Question

The Republic of Gizmovia wants to maintain the exchange rate of its currency, the gizmo, at $0.50, but the current exchange rate for the gizmo is $0.40. If Gizmovia uses monetary policy to bring the exchange rate for the gizmo to $0.50, it should _____ interest rates, which will _____ capital outflows of gizmos.
a) decrease; decrease
b) decrease;increase
c) increase; increase
d) increase;decrease

Answer 1

Answer:

D) increase; decrease

Explanation:

in order to appreciate the currency by $0.10, the interest rates need to be increased. This will encourage people to save more and thus increase the demand for gizmo that will increase the exchange rate.

This increased interest rate will also decrease the capital outflow out of the country as more people will be willing to take advantage of higher interest on savings in the country than investing outside of the country to leverage opportunities. Thus option D is the right choice.

Hope that helps.