In a flexible exchange rate regime, a decrease in the expected future exchange rate will cause:
A) the IP curve to shift to the right/down.
B) the IP curve to shift to the left/up.
C) a movement along the IP curve.
D) the IP curve to become vertical.
E) the IP curve to become horizontal.

Question

Quizplus · Accepted Answer

A decrease in the expected future exchange rate means that the domestic currency is expected to appreciate in the future. This leads to a decrease in the current demand for foreign goods which causes a decrease in the current domestic output. As a result, the IS curve will shift to the left/upwards. This leads to a decrease in the interest rate which causes a decrease in the demand for the domestic currency. This shift in the demand for the domestic currency will cause the IP curve to shift to the left/upwards.

In a Flexible Exchange Rate Regime, a Decrease in the Expected