Domestic Financial Policies

Autonomy (Closed Economy)
Fixed Exchange Rates
Free Capital Movement

The expansive effect of a given increase in the stock of money under the floating exchange rate system will be the greater, the greater the responsiveness of the international capital flow to movements in the rate of interest. If there were no responsiveness whatever, the exchange rate would depreciate to the point at which, despite the monetary expansion, no change occurred in the current balance of payments. Income would expand to the same extent as in a closed economy. On the other hand, if the capital flow were infinitely elastic with respect to the interest rate, the exchange rate would depreciate to the point at which the balance of trade became so favorable, and income increased so much, that the rate of interest remained at its original level. This implies that money income would increase by the same percentage as the stock of money.