Which one of the following statements best explains why U.S. monetary policy in

Question

Which one of the following statements best explains why U.S. monetary policy in an open economy is more effective than in a closed economy?

a. Lowering interest rates means that U.S. citizens can increase their borrowing and increase their expenditures on foreign goods, thus increasing aggregate demand. b. Lowering interest rates decreases foreign direct investment, allowing for more domestic investment, thus increasing aggregate demand. c. Lowering interest rates causes the dollar to depreciate, which increases exports and decreases imports, thus increasing aggregate demand. d. Lowering interest rates increases foreign direct investment, thus leading to an increase in aggregate demand. e. Lowering interest rates causes the dollar to appreciate, which increases imports and decreases exports, thus increasing aggregate demand.

Explanation / Answer

If United States pursues expansionary monetary policy then in an open economy set up such policy administration will lead to increase in money supply which in result will lower the interest rates.

This fall in the interest rate will prompt the outflow of investment from United States leading to increase in supply of dollars. This will lead to depreciation of dollar.

Depreciation of dollar will boost exports and will reduce imports leading to increase in aggregate demand and real GDP.

The correct answer is the option (c).

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