Final answer:
A contractionary monetary policy under a fixed exchange rate system causes domestic currency appreciation, reduces net exports and aggregate demand, leading to a decreased GDP. It can also deplete foreign reserves as the central bank maintains the exchange rate. Cheaper imports may stimulate aggregate supply, balancing GDP over time.
Step-by-step explanation:
Under a fixed exchange rate system, a contractionary monetary policy can have several effects. When a country's central bank enacts contractionary monetary policy, typically by raising interest rates, this tends to attract foreign capital, causing the domestic currency to appreciate. An appreciated currency makes a country's exports more expensive to foreign buyers and imports cheaper to domestic consumers. As a result, exports would decrease, and imports would increase, leading to a fall in net exports (EX - IM). This decrease in net exports reduces aggregate demand, which can lead to a decrease in the Gross Domestic Product (GDP). The appreciation in currency can also affect the foreign reserves; to maintain the fixed exchange rate, the central bank may have to sell foreign currency from its reserves to buy domestic currency, thus depleting the foreign reserves.
Overall, the impact of contractionary monetary policy in a fixed exchange rate regime is to appreciate the domestic currency, reduce net exports and aggregate demand, which can lower output (GDP). However, the increase in imports due to cheaper prices may stimulate the aggregate supply, potentially stabilizing the GDP in the long run, albeit at a lower price level.