Answer to Question 2:
When the exchange rate is fixed, the domestic money supply is
endogenous.
True or False?
The answer is true. By endogenous, we mean that the level of the
variable is determined within the equilibrating process by the
equations of the model. This is in contrast to exogenous variables,
which are determined outside the model independently of
the process of achieving equilibrium. Under fixed exchange rates
domestic equilibrium is determined by the condition of goods
market equilibrium in conjunction with the world interest rate
and other rest-of-world variables independently of monetary
factors. The authorities are then forced to produce a money
supply that will maintain asset or portfolio equilibrium, given
the equilibrium levels of output and/or prices. The nominal
money supply is thus determined within the model's equilibrating
process.
Return to Lesson