Which of the following would decrease the real exchange rate in the basic model of a small open economy in the long run?
A) a personal income tax cut
B) a reduction in government spending
C) a tariff on imports
D) an increase in investment

Question

Quizplus · Accepted Answer

In the basic model of a small open economy, a reduction in government spending would decrease the demand for domestic currency and thus reduce its real exchange rate in the long run. A personal income tax cut and an increase in investment would increase domestic demand, which would lead to an appreciation of the real exchange rate. A tariff on imports would increase the demand for domestic goods relative to foreign goods, leading to an appreciation of the real exchange rate.

Which of the Following Would Decrease the Real Exchange Rate