Under what circumstances will monetary policy be most effective?
A)An economy closed to international trade.
B)An open economy with a fixed exchange rate.
C)An open economy with a flexible exchange rate.
D)An open economy with a managed float.

Question

Quizplus · Accepted Answer

Monetary policy is most effective in an open economy with a flexible exchange rate. This is because under a flexible exchange rate regime, the central bank can use monetary policy to influence the interest rates which in turn affect the exchange rate. In an open economy, changes in the exchange rate can affect exports, imports, inflation, and economic growth. Hence a flexible exchange rate regime lets the central bank respond appropriately to any shocks to the economy, making monetary policy more effective in such an economy.

Under What Circumstances Will Monetary Policy Be Most Effective