(a)What happens to the fundamental value of a country's exchange rate when it raises its money supply in a fixed exchange-rate system? Does this make the currency overvalued or undervalued if originally the official rate equaled the fundamental value?(b)What happens to the fundamental value of a country's exchange rate when the foreign country raises its money supply? Does this make the currency overvalued or undervalued if originally the official rate equaled the fundamental value?(c)So, if a country wants to maintain its official rate equal to its fundamental value, what must it do when the foreign country raises its money supply? What happens to inflation?
What will be an ideal response?
| (a) | Fundamental value falls below the official rate, so the currency is overvalued. |
| (b) | Fundamental value increases above the official rate, so the currency is undervalued. |
| (c) | The country must raise its money supply. This leads to inflation worldwide. |
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