CFA Practice Question

CFA Practice Question

The nation of Myopia is having a massive inflation problem. To stabilize prices, the Myopian Central Bank decides to acquire large numbers of Capitalian Dollars (a very stable currency) and offer to exchange five Myopian Pesos for one Capitalian Dollar on demand. How does this impact the monetary base and the effective money supply for the nation of Capitalia?
A. both decrease.
B. no change, decrease.
C. decrease, increase.
Explanation: The monetary base is made up of currency and bank reserves. In this case, Myopia has taken large amounts of currency out of circulation in Capitalia, but the expatriated currency is technically still part of the monetary base. Therefore the base has not changed, but the effective money in circulation has decreased. This is one of the problems economists face in attempting to measure the real money supply.

User Contributed Comments 7

User Comment
dimos I dont get it. Can anyone explain to me why effective money supply for the nation of Capitalia decreases?
danlan I think effective money supply decreased since large amounts of currency was used to acquire Capitalian dollars, and money supply is reduced by this amount.
DAS11 Money supply decreases because Myopia has taken a large amount of the currently out of circulation (decrease in MS), but the money still exists (no change to monetary base)
dskim116 agree with DAS11
chamad Myopian, Capitalian...beautiful disturbing names!...just a joke...2 days left
grezavi Monetary Base the way the question structed it referred to Pyopia's not Cap's. Money Supply should have been increased to keep the currency at its eq. since it is a large stable currency
Kashi2010 You must first follow the inference that, in order to protect their capital/wealth, the citizens of Myopia take up the offer and exchange their Pesos for Dollars. In doing so the amount of pesos in circulation will decrease, but the total (theoretical) value of reserves held in the system will not be affected.
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