Why is the multiplier for contractionary fiscal policy smaller in an open econom

Question

Why is the multiplier for contractionary fiscal policy smaller in an open economy?

A. Contractionary fiscal policy increases the deficit, which raises the interest rate, which reduces the foreign exchange value of the dollar, which increases net exports.

B. Contractionary fiscal policy reduces the deficit, which raises the interest rate, which raises the foreign exchange value of the dollar, which increases net exports.

C. Contractionary fiscal policy reduces the deficit, which reduces the interest rate, which reduces the foreign exchange value of the dollar, which decreases net exports.

D. Contractionary fiscal policy reduces the deficit, which reduces the interest rate, which reduces the foreign exchange value of the dollar, which increases net exports.

Explanation / Answer

Correct option:

D. Contractionary fiscal policy reduces the deficit, which reduces the interest rate, which reduces the foreign exchange value of the dollar, which increases net exports.

The decrease in the foreign exchange value of dollar makes the country more competitive in exports and makes imports expensive, thereby increasing exports as well as net exports. As a result, the multiplier effect of the fiscal policy is smaller.

Related Questions

Navigate

• Browse (All)
• Browse W
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.