International capital flows in an open economy have the effect of
A)increasing the power of fiscal policy.
B)reducing the power of fiscal policy.
C)reducing the power of fiscal policy in an expansion, and increasing it in a contraction.
D)increasing the power of fiscal policy in an expansion, and reducing it in a contraction.

Question

Quizplus · Accepted Answer

International capital flows can reduce the power of fiscal policy by making it more difficult for governments to control interest rates and inflation. When there is a large inflow of capital, it can push up the value of the country's currency and reduce the competitiveness of its exports. This can lead to a trade deficit and slower economic growth, making it more difficult for governments to use fiscal policy to stimulate the economy. Similarly, when there is a large outflow of capital, it can lead to a depreciation of the currency and higher inflation, making it more difficult for governments to use fiscal policy to control inflation. Therefore, international capital flows can limit the effectiveness of fiscal policy in an open economy.

International Capital Flows in an Open Economy Have the Effect