In a short-run model of a large open economy with a floating exchange rate, a fiscal expansion causes an increase in:
A) the exchange rate and a fall in net exports but has no effect on income.
B) the money supply and an increase in income but has no effect on the exchange rate.
C) income, the interest rate, and net exports, but a decrease in investment and in the exchange rate.
D) income, the interest rate, and the exchange rate, but a decrease in investment and net exports.

Question

Quizplus · Accepted Answer

According to the short-run model of a large open economy with a floating exchange rate, a fiscal expansion results in an increase in income due to increased government spending, which then leads to an increase in the interest rate. This increase in interest rate causes an appreciation of the domestic currency, leading to a decrease in net exports. The decrease in net exports and the increase in the interest rate together cause a decrease in investment, leading to an overall decrease in investment and net exports. Therefore, income, the interest rate, and the exchange rate all increase, while investment and net exports decrease.

In a Short-Run Model of a Large Open Economy with a Floating