In the flexible exchange rate environment with perfect capital mobility, a fiscal stimulus will be linked to which of the following statements?
Show Hint
- Fiscal policy increases the domestic outcome
- Fiscal policy does not increase the domestic output
- Fiscal policy leads domestic exports to fall
- Fiscal policy appreciates the domestic currency
The Correct Option is B, C, D
Solution and Explanation
Step 1: Understand the relationship between fiscal policy and exchange rates
In a flexible exchange rate system with perfect capital mobility, the fiscal stimulus can have several effects, but it does not directly increase domestic output. Rather, the increased government spending typically leads to higher interest rates, which can cause the domestic currency to appreciate, thereby reducing exports.
Step 2: Analyze the options
Now, let's analyze the options:
- (A) This option is incorrect because, in an open economy with perfect capital mobility and a flexible exchange rate, fiscal policy is not directly linked to an increase in domestic output.
- (B) This is correct because fiscal policy does not lead to an increase in output due to the crowding-out effect and the appreciation of the domestic currency.
- (C) This is correct because an appreciation of the domestic currency makes exports more expensive for foreign buyers, leading to a fall in exports.
- (D) This is correct because fiscal policy can lead to an appreciation of the domestic currency due to higher interest rates, making the currency more attractive to foreign investors.
Step 3: Conclusion
Thus, the correct answers are (B), (C), and (D).
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