When analyzing problems in maintaining a fixed exchange rate system, simplifying assumptions must be made. Which of the following is NOT a simplifying assumption?
A) The domestic government issues no bonds.
B) The price level is stable and purchasing power parity (PPP) holds.
C) Output is exogenous.
D) Everyone believes the peg will hold, so there is uncovered interest parity (UIP).

Question

Quizplus · Accepted Answer

Assuming that the domestic government issues no bonds is not a simplifying assumption in maintaining a fixed exchange rate system. In fact, the domestic government's bond issuance can play a significant role in affecting the exchange rate and the overall stability of the system. The other choices (B, C, and D) are common simplifying assumptions made in analyzing fixed exchange rate systems.

When Analyzing Problems in Maintaining a Fixed Exchange Rate System