Suppose policy makers are pursuing a policy to fix the exchange rate. In such a system with perfect capital mobility, an open market purchase of domestic bonds by the domestic central bank will eventually result in:
A) a gradual decrease in the domestic interest rate.
B) a change in the composition of the monetary base.
C) a permanent increase in the monetary base.
D) a permanent decrease in the monetary base.
E) a gradual increase in the domestic interest rate.

Question

Quizplus · Accepted Answer

An open market purchase of domestic bonds by the central bank changes the composition of the monetary base by increasing reserves, but under a fixed exchange rate with perfect capital mobility, the central bank must intervene to maintain the exchange rate, preventing a permanent change in the monetary base.

Suppose Policy Makers Are Pursuing a Policy to Fix the Exchange