Under a floating exchange rate regime with a low degree of capital mobility, a change in the exchange rate value of domestic currency following expansionary fiscal policy will tend to:
A)deteriorate the current account.
B)decrease the country's holdings of official reserve assets.
C)give a trade-based stimulus to domestic production.
D)cause a surplus in the financial account.

Question

Quizplus · Accepted Answer

Under a floating exchange rate regime with a low degree of capital mobility, expansionary fiscal policy will lead to an increase in domestic demand and output. This will lead to an increase in imports, causing a deterioration of the current account. However, as capital mobility is low, the inflow and outflow of foreign investment will be limited. Therefore, the increase in output will lead to a trade-based stimulus to domestic production, which will increase exports and partially offset the impact of the deteriorating current account. Thus, choice C is the best answer. The other options are unlikely to occur under the given conditions.

Under a Floating Exchange Rate Regime with a Low Degree