In a small open economy with a floating exchange rate, if the government increases the money supply, then in the new short-run equilibrium the:
A) interest rate falls and the level of investment rises.
B) exchange rate falls and net exports increase.
C) interest rate falls but the level of investment does not rise.
D) exchange rate falls but net exports do not increase.

Question

Quizplus · Accepted Answer

In a small open economy with a floating exchange rate, an increase in the money supply leads to a depreciation of the exchange rate, making exports cheaper and imports more expensive. This results in an increase in net exports.

In a Small Open Economy with a Floating Exchange Rate