Assume that Australian dollar is pegged to the U.S dollars with the exchange rate of E$/£ = 2. The Reserve Bank of Australia (RBA) maintains this exchange rate all the time. 

(A) What should be the interest rate in Australia today, i$, to maintain the par value of the exchange rate at $2 per £1? Explain the reason. [5 marks] 

(B) Should the RBA raise or reduce the money supply in Australia today to maintain the par value of the exchange rate at $2 per £1? Explain the reason. [4 marks] [hint: consider the trillemma] 

(C) What should be the Australian money supply in the long-run to maintain the par value of the exchange rate at $2 per £1? Explain the reason.

Answer rating: 100% (QA)

A To maintain the exchange rate peg of E 2 the interest rate in Australia i should equal the interest rate in the United States i This condition is kn... View the full answer