Final answer:
Monetary policy affects interest rates, exchange rates, and inflation rates under a flexible exchange rate system.
Step-by-step explanation:
Under a flexible exchange rate system, monetary policy affects all of the above: interest rates, exchange rates, and inflation rates.
Monetary policy refers to the actions taken by a country's central bank to influence the supply of money and credit in the economy. In a flexible exchange rate system, where the value of a country's currency is determined by market forces, changes in monetary policy can have an impact on various variables.
For example:
- Interest rates: By adjusting the interest rates, the central bank can influence borrowing costs, which in turn affects consumer spending, investment, and economic growth.
- Exchange rates: Changes in monetary policy can lead to changes in interest rates, which can affect the demand for a country's currency in the foreign exchange market. This, in turn, can impact the exchange rate.
- Inflation rates: Monetary policy plays a crucial role in controlling inflation. By adjusting interest rates and managing the money supply, the central bank can influence the level of inflation in the economy.