Under a floating exchange rate regime, in the very short run (before the exchange rate adjusts), expansionary fiscal policy will lead to:
A)improvement in both current account and financial account.
B)improvement in current account but deterioration in financial account.
C)deterioration in current account but improvement in financial account.
D)deterioration in both current account and financial account.

Question

Quizplus · Accepted Answer

Under a floating exchange rate regime, an expansionary fiscal policy leads to an increase in demand for goods and services, which leads to an increase in imports and a deterioration in the current account in the short run. However, the increase in demand also leads to an increase in the interest rate, which attracts foreign investment and improves the financial account. Therefore, there will be a deterioration in the current account but an improvement in the financial account.

Under a Floating Exchange Rate Regime, in the Very Short