An increase in real income with constant prices and domestic credit leads to the same effects under both fixed and purely flexible exchange rates.

Question

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Under a fixed exchange rate system, an increase in real income typically leads to a higher demand for imports, which can result in a balance of payments deficit if not offset by an equal increase in exports. The government or central bank may need to intervene in the foreign exchange market to maintain the fixed rate, possibly depleting foreign reserves. Under a purely flexible exchange rate system, an increase in real income would still likely increase import demand, but the exchange rate would adjust automatically to balance the demand for and supply of foreign currency, without the need for central bank intervention. Thus, the effects on the economy and policy responses differ between the two systems.

An Increase in Real Income with Constant Prices and Domestic