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    Question

    Under a flexible exchange rate regime, an expansionary

    monetary policy will most likely lead to:
    A Capital inflow and currency appreciation. Correct Answer Incorrect Answer
    B Capital inflow and currency depreciation. Correct Answer Incorrect Answer
    C Capital outflow and currency appreciation. Correct Answer Incorrect Answer
    D Capital outflow and currency depreciation. Correct Answer Incorrect Answer
    E No change in the exchange rate. Correct Answer Incorrect Answer

    Solution

    Expansionary monetary policy lowers domestic interest rates. This makes domestic assets less attractive, leading to capital outflow (or reduced inflow). The increased supply of the domestic currency in the forex market to buy foreign assets leads to a depreciation of the domestic currency.

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