In the New Keynesian open economy model,government spending
A) is an effective stabilization tool with a flexible exchange rate, and an ineffective stabilization tool with a fixed exchange rate
B) is an ineffective stabilization tool with a flexible exchange rate, and an effective stabilization tool with a fixed exchange rate; prices are flexible.
C) is an ineffective stabilization tool with a flexible exchange rate, and an ineffective stabilization tool with a fixed exchange rate; net exports depends on the relative price of foreign goods to domestic goods.
D) is an effective stabilization tool with a flexible exchange rate, and an effective stabilization tool with a fixed exchange rate.

Question

Quizplus · Accepted Answer

In the New Keynesian open economy model, with flexible prices, government spending is ineffective with a flexible exchange rate because exchange rate adjustments offset fiscal policy effects. However, with a fixed exchange rate, government spending can be effective as it directly influences output without exchange rate adjustments.

In the New Keynesian Open Economy Model,government Spending