In a small open economy with a flexible exchange rate, a monetary injection by the Bank of Canada causes which of the following?
A)It causes the dollar to appreciate.
B)It causes net exports to fall.
C)It causes an additional decrease in demand for Canadian-produced goods and services that is not realized in a closed economy.
D)It causes a shift of the aggregate demand curve farther to the right than it would in a closed economy.

Question

Quizplus · Accepted Answer

In a small open economy with a flexible exchange rate, a monetary injection by the Bank of Canada would not cause the dollar to appreciate (choice A) because the exchange rate is flexible. It would not cause net exports to fall (choice B) because a flexible exchange rate would adjust to maintain external balance. However, it would cause a decrease in demand for Canadian-produced goods and services (choice C) because some of the monetary injection would be used to purchase foreign goods and services, reducing the demand for domestic goods and services relative to foreign ones. Additionally, it would cause a shift of the aggregate demand curve farther to the right than it would in a closed economy (choice D) because some of the monetary injection would also increase foreign demand for Canadian-produced goods and services, increasing exports. Therefore, the overall effect of the monetary injection on the economy would be larger than in a closed economy.

In a Small Open Economy with a Flexible Exchange Rate