What are the results of a contractionary monetary policy in an open economy with floating exchange rates and internationally mobile capital?
A)The dollar appreciates, which leads to an increase in exports and a decrease in imports.The country therefore winds up with a deficit in capital and a surplus in its balance of trade.
B)The dollar appreciates, which attracts foreign capital.Also, imports rise and exports decline.The country therefore winds up with a surplus in capital and an increase in its trade deficit.
C)The dollar depreciates, which attracts foreign capital.Also, exports rise and imports decline.The country therefore winds up with a deficit in capital and a surplus in its balance of trade.
D)The dollar depreciates, which leads to a larger real GDP and a larger trade surplus.

Question

Quizplus · Accepted Answer

A contractionary monetary policy (such as increasing interest rates) will lead to a higher value of the domestic currency (dollar appreciates) in an open economy with floating exchange rates, as there will be an increase in demand for the currency due to the higher interest rates. This will attract foreign capital to invest in the domestic economy, leading to a surplus in capital. However, the higher currency value will also make imports cheaper and exports more expensive, causing a decline in exports and a rise in imports, leading to an increase in the trade deficit.

What Are the Results of a Contractionary Monetary Policy in an Open