Under a clean floating exchange rate system, a central bank implements a substantial increase in domestic interest rates to combat inflation. All other things being equal, this monetary policy action is most likely to cause:
a depreciation of the domestic currency as short-term capital flows out of the economy, boosting aggregate demand.
a contraction in aggregate demand, reinforced by an appreciation of the currency which increases the foreign currency price of exports.
an expansion in aggregate demand because the resulting appreciation of the domestic currency reduces the domestic price of imported raw materials.
no change in the exchange rate, as a floating exchange rate system automatically insulates the domestic currency from international capital movements.
