Question
Fill in the blanks. The following figure describes how a balance of payments crisis occurs. Suppose the foreign exchange market expects the government to devalue
Fill in the blanks.
The following figure describes how a balance of payments crisis occurs. Suppose the foreign exchange market expects the government to devalue the currency in the future and adopt a new fixed exchange rate E1>E0. This leads to a rightward shift in the curve that measures the expected domestic currency return on foreign currency deposits. Since the exchange rate remains fixed at E0, the domestic interest rate must rise to R*+(E1-E0)/E0. The central bank must ______________ foreign reserves and _____________ the money supply in response.
Select one:
a. purchase; increase
b. purchase; decrease
c. sell; increase
d. sell; decrease
Exchange rate, E E0 1 R* +(E-EJE 1 R* +(EO-EYE Domestic interest rate, R 0 R R' +(E-EYE 1 1 1 L(R, Y) 1 1 M2 2 M Real money supply 1 Real domestic money holdingsStep by Step Solution
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