Under a floating exchange rate system, a country’s ability to expand o

QUESTION

Under a floating exchange rate system, a country’s ability to expand or contract its money supply as it sees fit is limited by the need to maintain exchange rate parity.

Indicate whether the statement is true or false.

ANSWER

FALSE
It is argued that under a fixed system, a country’s ability to expand or contract its money supply as it sees fit is limited by the need to maintain exchange rate parity. Monetary expansion can lead to inflation, which puts downward pressure on a fixed exchange rate. Similarly, monetary contraction requires high interest rates (to reduce the demand for money). Higher interest rates lead to an inflow of money from abroad, which puts upward pressure on a fixed exchange rate.