Why is the multiplier for contractionary fiscal policy smaller in an open econom

Question

Why is the multiplier for contractionary fiscal policy smaller in an open economy?

A. Contractionary fiscal policy reduces the deficit, which reduces the interest rate, which reduces the foreign exchange value of the dollar, which increases net exports.

B. Contractionary fiscal policy reduces the deficit, which reduces the interest rate, which reduces the foreign exchange value of the dollar, which decreases net exports.

C. Contractionary fiscal policy increases the deficit, which raises the interest rate, which reduces the foreign exchange value of the dollar, which increases net exports.

D. Contractionary fiscal policy reduces the deficit, which raises the interest rate, which raises the foreign exchange value of the dollar, which increases net exports.

Explanation / Answer

Ans: A. Contractionary fiscal policy reduces the deficit, which reduces the interest rate, which reduces the foreign exchange value of the dollar, which increases net exports.

Explanation: Contractionary fiscal policy cuts goverment spending and raises taxes reduces budget deficit , interest rate and foreign exchange value of the dollar and increases net exports. Thus, in an open economy, a Contractionary fiscal policy will have a smaller impact on aggregate demand and less effective in slowing down the economy.

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