Question

1. Can a country with a fixed exchange rate pursue an independent monetary policy to eliminate a recession?

2. How does an expansionary fiscal policy affect the current account under fixed exchange rates?

3. State and explain two reasons why Europe is not an Optimum Currency Area.

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No. When the central back increases the amount of money circulated to stimulate the economy, some of the increase flows into the foreign exchange market and the currency depreciates because the foreign exchange market has a larger amount of the domestic currency. Under a fixed exchange rate, the central sells foreign assets (foreign currencies) for domestic money in the foreign exchange market. As the money the central back takes goes out of circulation, and the asset market equilibrium shifts back toward its initial position or bare minimum offsets the expansionary effect the central bank has intended to have....

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