Answer to Question #275001 in Macroeconomics for kay

Question

a) How is money supply different in a fixed compared to a flexible exchange rate system? b) Explain why does monetary policy lose autonomy in a fixed exchange rate system ? c) Explain the assumptions of flexible exchange rate and fixed exchange rate. Which is an appropriate system for an small island economy of the Pacific ? 

Answer 1

How is money supply different in a fixed compared to a flexible exchange rate system?

Both impose costs on economies. Floating exchange rates charge a fee by discouraging trade and investment. Fixed exchange rates impose a cost by limiting policymakers' ability to pursue domestic stabilization, making the economy less stable.

b) Explain why monetary policy loses autonomy in a fixed exchange rate system?

In a fixed exchange rate system, monetary policy becomes ineffective because the persistence of the exchange rate acts as a constraint.

c) Explain the assumptions of flexible exchange rate and fixed exchange rate. Which is an appropriate system for a small island economy of the Pacific?

flexible exchange rates assume perfect substitutability of assets, while fixed exchange rates assume that Prices are flexible and all transactions take place in the gold

A fixed exchange rate is appropriate for a small island.