1. In a small open economy with flexible exchange rates, a fiscal contraction wo
ID: 1115642 • Letter: 1
Question
1. In a small open economy with flexible exchange rates, a fiscal contraction would
A) cause an exchange rate appreciation.
B) have no effect on domestic output.
C) increase domestic output.
D) decrease domestic output.
2. In a small open economy with flexible exchange rates, a contractionary monetary policy would
A) cause an exchange rate depreciation in the short run.
B) increase domestic output in the short run.
C) decrease domestic output in the short run.
D) decrease domestic output in the long run.
A) cause an exchange rate appreciation.
B) have no effect on domestic output.
C) increase domestic output.
D) decrease domestic output.
2. In a small open economy with flexible exchange rates, a contractionary monetary policy would
A) cause an exchange rate depreciation in the short run.
B) increase domestic output in the short run.
C) decrease domestic output in the short run.
D) decrease domestic output in the long run.
Explanation / Answer
Answer.)
Q1.) B) have no effect on domestic output.
The Mundell-Fleming model predicts that a fiscal contraction will induce a fall in the real exchange rate. This results in a rise in net export demand, which offsets the contraction. Thus, the net effect on income is 0.
Q2.) C) decrease domestic output in the short run.
The Mundell-Fleming model predicts that a monetary contraction will put upward pressure on the real exchange rate. This results in a fall in net export demand, which produces a lower level of income.
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