The use of expansionary or "easy" fiscal policy by a country's government in a situation of fixed exchange rates will, other things equal, initially lead to __________ of the country's current account balance (or trade balance); if short-term financial capital is relatively mobile between countries (i.e., the BP curve is flatter than the LM curve), the policy initially __________ of the country's capital/financial account balance.
A) an improvement; also leads to an improvement
B) an improvement; leads to a deterioration (or worsening)
C) a deterioration (or worsening); leads to an improvement
D) a deterioration (or worsening); also leads to a deterioration (or worsening)

Question

Quizplus · Accepted Answer

Under a fixed exchange rate system, expansionary fiscal policy will initially increase domestic income, leading to increased imports and a deterioration of the current account balance. If short-term financial capital is relatively mobile, the increased demand for foreign currency to finance the higher imports will lead to an inflow of financial capital, improving the capital/financial account balance.

The Use of Expansionary or "Easy" Fiscal Policy by a Country's