In a small open economy with perfect capital mobility,if the exchange rate is flexible,which of the following would be the effect of an expansionary monetary policy?
A)It would cause the domestic interest rate to increase permanently.
B)It would cause the domestic interest rate to decrease permanently.
C)It would cause the domestic interest rate to increase temporarily.
D)It would cause the domestic interest rate to decrease temporarily.

Question

Quizplus · Accepted Answer

An expansionary monetary policy would increase the money supply, leading to a decrease in the domestic interest rate. This decrease in interest rate would lead to an increase in capital outflows, causing an depreciation of the domestic currency, which would then make exports more competitive and imports more expensive. This would lead to an increase in aggregate demand for domestic goods and services, ultimately resulting in a temporary increase in the domestic interest rate due to increased borrowing for investment and consumption.

In a Small Open Economy with Perfect Capital Mobility,if the Exchange