Given an open economy with high capital mobility and floating exchange rates,suppose an expansionary fiscal policy is implemented to combat recession.The initial and secondary effects of the policy
A) cause aggregate demand to increase,thus strengthening the policy's expansionary effect on real output
B) cause aggregate demand to decrease,thus eliminating the policy's expansionary effect on real output
C) have conflicting effects on aggregate demand,thus weakening the policy's expansionary effect on real output
D) have conflicting effects on aggregate demand,thus strengthening the policy's expansionary effect on real output

Question

Quizplus · Accepted Answer

In an open economy with high capital mobility and floating exchange rates, an expansionary fiscal policy typically leads to an increase in interest rates, attracting foreign capital inflow and leading to an appreciation of the currency. This appreciation makes exports more expensive and imports cheaper, leading to a decrease in net exports and a decrease in aggregate demand. This is the primary effect of the policy. The secondary effect is that the increase in government spending or tax cuts might stimulate consumption and investment, leading to an increase in aggregate demand. These two effects tend to have conflicting impacts on aggregate demand and can weaken the expansionary effect of the policy on real output. Therefore, option C is the correct answer.

Given an Open Economy with High Capital Mobility and Floating