Assume the model of simultaneous short-run equilibrium in output market and asset market under the floating exchange rate regime. How will the basic change in AA schedule work? Select one – the most appropriate answer.

Question

BlackTom AI · Accepted Answer

The question asks about the multimarket model with simultaneous short-run equilibrium in the output (goods) market and the asset (money/foreign exchange) market under a floating exchange rate regime, focusing on how the basic change in the AA schedule operates.
Option 1: Output decreases → demand for money declines → interest rate falls → domestic currency depreciates → upside movement along AA curve.
- This sequence starts with a fall in output, which reduces income and thus money demand. Less money demand tends to lower the interest rate. With a lower interest rate under a floating regime, capital may flow out, leading to depreciation of the domestic currency (E rises if depreciation is defined that way; typically E denotes the price of foreign currency in terms of domestic currency, so depreciation means E↑). The AA curve represents combinations of output and exchange rate that equilibrate the asset market given the money market; a drop in i and depreciation can move along the AA curve toward higher E and lower Y, i.e., an upward movement along AA if we parameterize the curve accordingly. This chain is consistent with standard Mundell-Fleming intuition when a contraction reduces money demand and lowers interest rates, provoking depreciation.
Option 2: Domestic currency depreciation → decrease in domestic demand → increase in output → upside movement along DD curve.
- Depreciation directly affecting domestic demand is not a standard first-pass implication of a simple AA shift: depreciation tends to stimulate net exports but total domestic demand dynamics are more nuanced; moreover, the DD curve (demand for goods) is not the immediate channel described by the AA shift in a floating regime. This option also asserts an increase in output, which contradicts the assumption of a basic change that typically would reduce output along the AA adjustment path after a contraction.
Option 3: Output increases → demand for money jumps → interest rate drops → domestic currency appreciates → downside movement along AA curve.
- An increase in output would raise money demand, not jump; higher money demand tends to push up interest rates, not drop them. A currency appreciation follows higher interest rates in standard Mundell-Fleming logic, not depreciation. The direction of movement along AA here (downside) would be inconsistent with the described chain starting from higher output and higher money demand. Thus this sequence is not coherent with the typical AA adjustment under floating rates.
Option 4: Output decreases → demand for money jumps → interest rate goes up → domestic currency appreciates → upside movement along AA curve.
- Here, a fall in output leads to a jump in money demand (the opposite of the standard effect), which would push interest rates up, not down. An appreciation of the domestic currency would accompany higher interest rates in a fixed- or flexible-rate context, but the direction (up in interest rate) with appreciation does not align with the conventional AA response to a contraction. This path also contradicts the usual currency reaction to falling output and money demand.
Option 5: All answers are wrong.
- Given the typical interpretation of the AA schedule under a floating exchange rate regime, the first option is broadly consistent with the standard mechanism of a negative demand shock: output falls, money demand falls, interest rate falls, currency depreciates, and the economy moves along the AA curve in the corresponding direction. While wording nuances exist across models, this option best matches the canonical chain of causation described by the AA adjustment.
Option 6: Domestic currency appreciation → decrease in domestic interest rate → decrease in output → downside movement along DD curve.
- Appreciation with a decrease in interest rate is inconsistent: currency appreciation is typically associated with higher interest rates or stronger capital inflows, not a drop in rates. The sequence also links currency appreciation to a decrease in output and to movement along the DD curve, which mixes asset and goods-market channels in a way that does not align with the standard AA adjustment under floating rates.

In summary, option-by-option reasoning shows that the first option presents the most coherent chain of effects for a basic change in the AA schedule in a floating-rate, simultaneous short-run equilibrium framework, while the other options contain mismatches in the direction of money-demand effects, interest-rate responses, or exchange-rate movements that are inconsistent with the typical AA adjustment path.

Assume the model of simultaneous short-run equilibrium in output market and asset market under the floating exchange rate regime. How will the basic change in AA schedule work? Select one – the most appropriate answer.单项选择题

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