If a country is on a fixed exchange rate régime and suffers a sudden temporary negative demand shock, which would be the most appropriate policy response?

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BlackTom AI · Accepted Answer

First, let me restate the situation and the available choices, noting that the provided data has an empty list of answer options and identifies a single proposed correct option: reduce taxes.
In a country operating under a fixed exchange rate regime, a sudden temporary negative demand shock reduces domestic demand and can threaten output and employment. With a fixed exchange rate, monetary policy is constrained because offsetting price-level or demand shocks through interest rate changes risks destabilizing the peg; the central bank must defend the fixed rate rather than pursue an independent monetary stimulus.
Now, considering policy responses to the shock: 
- Reducing taxes as a fiscal stimulus option can increase aggregate demand by leaving households and firms with more disposable income, thereby encouraging consumption and investment. Since monetary policy is limited by the fixed exchange rate, fiscal expansion becomes the main tool to counteract the fall in demand. This makes tax cuts a plausible response to support demand without altering the exchange rate.
- Other potential options (not provided in the list) would include increasing government spending or targeted fiscal measures to raise demand, which would also be expansionary under a fixed peg and help stabilize output.
- Devaluing or pursuing a literal depreciation of the currency would undermine a fixed exchange rate regime, since the central bank would have to adjust the peg or face reserve losses; this is typically not feasible or desirable under a fixed regime during a shock because it would entail moving away from the fixed rate commitment.
- Tightening monetary policy (raising rates) would worsen the demand shock by reducing credit and spending, and is generally inconsistent with countercyclical stabilization in the face of a downturn under a fixed peg.
- In a scenario with a fixed exchange rate, relying on exchange-rate adjustments to stimulate the economy is not an option, since the exchange rate is fixed and authorities must maintain the peg, limiting monetary policy autonomy.
Given these considerations, the most coherent response among typical options is to use expansionary fiscal policy, such as tax cuts, to raise aggregate demand while keeping the exchange rate fixed.
Note on the missing answer options: since no alternatives are provided, I focused the analysis on the rationale for a fiscal expansion (tax cuts or increased spending) as appropriate under a fixed exchange-rate regime facing a negative demand shock, and contrasted it with reasons why monetary and exchange-rate adjustments would be inappropriate in this setting.

01:220:300:01 INTERNATIONAL ECON Qz11: IS-LM; Fixed vs floating foreign exchange rate systems

If a country is on a fixed exchange rate régime and suffers a sudden temporary negative demand shock, which would be the most appropriate policy response?

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01:220:300:01 INTERNATIONAL ECON Qz11: IS-LM; Fixed vs floating foreign exchange rate systems

If a country is on a fixed exchange rate régime and suffers a sudden temporary negative demand shock, which would be the most appropriate policy response?

查看解析

登录即可查看完整答案

类似问题

Question17 An exchange rate regime where the domestic currency relative to a foreign currency is held within a defined band is termed as ______________. a pegged exchange rate a free float a managed float a fixed exchange rate a brokered exchange rate ResetMaximum marks: 1 Flag question undefined

Question5 An exchange rate regime where the domestic currency relative to a foreign currency is held within a defined band is termed as ______________. a managed float a free float a pegged exchange rate a brokered exchange rate a fixed exchange rate ResetMaximum marks: 1 Flag question undefined

Question4 An exchange rate regime where the domestic currency relative to a foreign currency is held within a defined band is termed as ______________. a free float a managed float a fixed exchange rate a brokered exchange rate a pegged exchange rate ResetMaximum marks: 1 Flag question undefined

A managed float exchange rate regime is best described as one in which:

How would you define a currency board?

The intersection of GG and LL for Norway determines

Why does the LL schedule have a negative slope? The economic stability loss from pegging to the area's currencies _______ as the degree of economic interdependence _______.

Question at position 24 A system in which currencies float against one another, with governments intervening to stabilize their currencies at particular target exchange rates is called a __.managed float systemlinked exchange-rate systemfree float systemfixed exchange-rate system

更多留学生实用工具

希望你的学习变得更简单

Why does the LL schedule have a negative slope? The economic stability loss from pegging to the area's currencies _ as the degree of economic interdependence _.