With a fixed exchange rate system and high capital mobility, internal balance is most effectively achieved by using
A) expansionary monetary policy to combat recession.
B) expansionary fiscal policy to combat recession.
C) contractionary monetary policy to combat recession.
D) contractionary fiscal policy to combat recession.

Question

Quizplus · Accepted Answer

In a fixed exchange rate system with high capital mobility, using expansionary fiscal policy is more effective for achieving internal balance, especially to combat recession. Expansionary monetary policy under these conditions would lead to capital outflows, as domestic interest rates would fall, making domestic assets less attractive to foreign investors. This could undermine the fixed exchange rate. Fiscal policy, on the other hand, directly stimulates demand without immediately affecting interest rates and capital flows, making it a more suitable tool for combating recession while maintaining the fixed exchange rate.

With a Fixed Exchange Rate System and High Capital Mobility