Why Is Monetary Policy More Effective in an Open Economy

question 68

Multiple Choice

Why is monetary policy more effective in an open economy than in a closed economy?

• A)Trade deficits affect exchange rates, which can offset adverse interest rate effects.
• B)Borrowers can choose to use foreign capital, so that interest rate effects are stronger than expected.
• C)Interest rate changes affect exchange rates, so that capital flows reinforce the effect of monetary policy.
• D)Banks can choose to lend to foreigners, so that interest rate effects are essentially nullified.

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Definitions:

M1

M1 encompasses the most liquid forms of money supply, including cash and assets that can quickly be converted to cash.

M2

M2 is a broader classification of money supply that accounts for currency in circulation and various other types of accounts that are less liquid than those in M1.

M1

Refers to the physical money supply that includes coins and notes in circulation as well as non-bank public holdings of checkable deposits.

M2

Includes all elements of M1 along with near money, such as savings deposits, time deposits under $100,000, and non-institutional money market funds.