In a small open economy with a flexible exchange rate, what does a monetary contraction by the Bank of Canada cause?
A) the dollar to depreciate
B) net exports to fall
C) an additional increase in demand for Canadian-produced goods that is not realized in a closed economy
D) a shift of the aggregate demand curve further to the right than in a closed economy

Question

Quizplus · Accepted Answer

Under a monetary contraction by the Bank of Canada, there will be a decrease in the money supply, leading to an increase in interest rates. This will cause a decrease in investment spending and consumption spending, leading to a decrease in aggregate demand. As a result, net exports will fall since the currency will appreciate making exports more expensive and imports cheaper.

In a Small Open Economy with a Flexible Exchange Rate