Answer to Question #216286 in Economics for alan

Question

1) Suppose that the US dollar and the Malaysian ringgit have a fixed exchange rate of $1/ RM4 and this exchange rate initially corresponds to equilibrium in the foreign exchange market. Draw and label a graph depicting the initial situation in the market for ringgitdenominated deposits. What conditions must be fulfilled in order for this market to be in equilibrium? Explain.

2) The United States is now pursuing an economic policy that raises the interest rate on dollar-denominated deposits (𝑖 $ ). Malaysia has an economic strategy that drives down the interest rate on ringgit-denominated deposits (𝑖 𝑅𝑀). Explain the effects of the two countries' policies using a graph as shown in part (a) above. What would have happened if the exchange rate between the dollar and the ringgit had been flexible rather than fixed? Why is this so?

3) What steps must the Malaysian central bank take if Malaysia sticks to its commitment to keep the exchange rate at $1/RM4? Please explain

Answer 1

1) Demand for money must be equal to supply of money in order for this market to be in equilibrium.

2) If the exchange rate between the dollar and the ringgit had been flexible rather than fixed, then more money will be deposited in dollars, and less money in ringgit, so the ringgit will depreciate against dollar.

3) If Malaysia sticks to its commitment to keep the exchange rate at $1/RM4, then Malaysian central bank should either decrease money supply, or increase the interest rate.