In an open economy, contractionary monetary policy will have a secondary effect on GDP because:
A)net exports will fall due to the lower foreign exchange value of the dollar.
B)net exports will rise due to the lower foreign exchange value of the dollar.
C)net exports will fall due to the higher foreign exchange value of the dollar.
D)net exports will rise due to the higher foreign exchange value of the dollar.

Question

Quizplus · Accepted Answer

Contractionary monetary policy is aimed at reducing the level of aggregate demand in the economy, which leads to a decrease in consumption and investment spending. This decrease in demand will cause a reduction in imports, which will increase net exports. However, the higher interest rates resulting from the policy will cause the exchange rate to appreciate, making exports more expensive and imports cheaper. This will decrease exports and increase imports, leading to a fall in net exports. Therefore, the net effect of contractionary monetary policy on GDP in an open economy is uncertain, but it is likely to be negative. Option C correctly identifies that net exports will fall due to the higher foreign exchange value of the dollar.

In an Open Economy, Contractionary Monetary Policy Will Have a Secondary