Under a flexible exchange rate system, expansionary fiscal policy

Question

Quizplus · Accepted Answer

Expansionary fiscal policy will cause an increase in aggregate demand, leading to higher imports and a deterioration of the trade balance under a flexible exchange rate system. As the exchange rate is flexible, an increase in demand for imports will lead to an increase in demand for foreign currency, causing the domestic currency to depreciate. This will make exports relatively cheaper and imports relatively more expensive, but it may not be enough to restore balance in the trade account. Thus, choice D is the best answer.

Under a Flexible Exchange Rate System, Expansionary Fiscal Policy