Explain with appropriate diagrams why an economy with fixed exchange rate cannot pursue an independent monetary policy.

An economy with a fixed exchange rate regime cannot pursue an independent monetary policy because its monetary policy is tied to the monetary policy of the country whose currency it has pegged to. In other words, the country must align its monetary policy with that of the anchor country to maintain the fixed exchange rate.

A fixed exchange rate regime means that the central bank of the country commits to maintaining a stable exchange rate between its currency and the currency of the anchor country. This is usually achieved by buying or selling the country's currency in the foreign exchange market to maintain the desired exchange rate.

To understand why an economy with a fixed exchange rate cannot pursue an independent monetary policy, consider the following diagram:

Diagram 1: The Money Market and a Fixed Exchange Rate

The diagram shows the money market and the foreign exchange market in an economy with a fixed exchange rate. The money market _________ _________ _______ ____ ___ ____ ____ ____ _________ ____ __________ ________.
_________ _________ ___ ___ _______.
____ _______ ______ _________ ____ ____ __________.
_________ __________ _______ ______ ____ _____ ________ _________ _________ _____.
_________ ______ _____ ____ ______ _______ _________.
_________ _______ ________ _________ ___ _________ _________ ______ _________ _____.
______ _______ ________ __________ _____ __________ ________ __________ ________ ____ _______.
_____ _________ __________ ____ _______ ______ _________ ___ ___.
_____ _________ ___ _________ ______ __________ ______.
___ _____ __________ __________ ____ _______ __________ _________ ____.
______ _____ ___ ______ _______ ________ ________ ____ ______.
_______ _______ ____ ___ ______ ____.
_________ __________ __________ ________ ______ _____ __________ ____ _________ ________ _________.
_____ _____ ______ ________ ________ __________ ____ _____ __________ _______.
__________ __________ ________ __________ _________.
___ ____ ________ ____ ____ _______ _____ _____.
________ ______ __________ ______ _____ ____ _______.
_______ _________ ______ _______ ________ ____ _______.
_________ _________ _____ ____ ______ __________ ___ _________.
____ ______ ___ ____ ____ ___ ____ ___ _________ ______ ____.
___ ______ ___ ________ _______ ______ _______ __________ _________ _____ ________.
______ ________ _____ ____ _____ _____ _______ ________ ____ _____ _____ _________.
________ ___ ______ __________ ________ _________ ______ ________ _____ ______.
______ ______ _____ _________ _____ ___.
_____ _________ ________ _________ _________ ______ ______ __________ ______ ________.
__________ _______ _________ _______ _______ ______ _____.
____ _________ ________ __________ _____ ______ _______ ___ ___ ___.
______ _______ _________ ______ ________ _________ ______ _______ _______ ________ ____.
____ ____ ____ ______ __________ _______ __________ ____ _______ ___ _________.
________ ________ __________ __________ ______.
_________ _______ ___ _____ _______ _________ __________ ______ ________ __________ _________.
____ __________ _________ _____ ____ ______ ____ _____.
________ ____ _________ _________ ____ _____ ________ ____ ___ ________ _____.
__________ _______ ____ _________ _____ _________.
___ ______ ____ ____ _______ ________ __________.
______ ______ ____ ____ __________ ____ __________ _________ _________ _______.
__________ _______ ___ ______ _______.
___ ____ _______ ________ ___ ___ _________ _____ __________.
_____ ________ ________ ___ ________ _______ __________ ____ ____ ________ __________ _____.
_________ _________ _______ __________ ______.
___ ____ ____ ____ __________ ______ ____ _____ __________ ___.
______ _________ _______ ____ _____ ___ ____ ________ _____.
___ _______ ____ ___ _____ __________.
__________ ___ ___ _________ ___ ________.
_________ ___ __________ ______ ____.
_________ _____ __________ __________ ____.
______ _______ _______ _____ _____ ____ _________ ________ ___ ______ ____.
___ _______ ___ __________ _______ _______ ____ ________.
_______ ___ ________ _________ ________ ________ ______ ____.
_____ ______ ______ ___ ______.
________ _______ __________ ________ _______ _____ ____ __________.
____ __________ __________ __________ ______ ________ __________ _____ _______ ___ _______ ___.
____ ______ ________ _____ _________.
________ ____ _______ ____ __________ ____ ___ ________ _____.
________ ____ ________ _______ ____ ________.
______ ___ ___ _________ ______.
____ ______ _______ ____ ____ _____ _________ ______ ________ __________.
________ ____ ________ ________.
Get Full Answer on WhatsApp