The following example supports which extension to the Monetary Approach to Exchange rates: Suppose the money supply increases.The initial change of the spot price exceeds that of its long-run value.
A) General equilibrium approach
B) Trade balance approach
C) Overshooting approach
D) Currency substitution approach

Question

Quizplus · Accepted Answer

The example described here supports the overshooting approach, which argues that exchange rates temporarily overshoot their long-run equilibrium values in response to monetary shocks, before converging back to their long-run values. This is because the short-run adjustment is determined by speculative behavior, which can amplify and prolong the effects of the shock. Hence, the initial change in the spot price will exceed its long-run value, but the exchange rate will eventually adjust back to reflect the fundamental factors affecting the economy. The other approaches listed (general equilibrium, trade balance, currency substitution) do not account for this short-term deviation from long-run equilibrium.

The Following Example Supports Which Extension to the Monetary Approach