Question

Suppose the government of Iraq is deciding what kind of monetary policy and exchange rate regime to choose. The government wants to ensure stability in international trade and investment by pegging the Iraqi dinar to the U.S. dollar. Which of the following policy choices will achieve this goal?

a. Maintaining capital controls with no independent monetary policy
b. Controlling the interest rate in the country and imposing restrictions on foreign exchange trading
c. Foregoing monetary policy autonomy without imposing capital controls

Answer 1

Answer:

B) Controlling the interest rate in the country and imposing restrictions on foreign exchange trading.

Explanation:

To ensure stability in international trade and investment, Iraq must keep a stable interest rate, so that investors can more easily calculate the cost of investing in Iraq. A stable interest rate is also correlated with a stable inflation rate, which is very important.

Because the Iraqi government was to peg the currency to the U.S. dollar, it has to establish capital controls (otherwise, the foreign-currency regime would be free-floating).