Given an open economy with high capital mobility and floating exchange rates, suppose an expansionary monetary policy is implemented to combat recession.Other things equal, the initial and secondary effects of the policy
A) cause aggregate demand to increase, thus strengthening the policy's expansionary effect on real output.
B) cause aggregate demand to decrease, thus eliminating the policy's expansionary effect on real output.
C) have conflicting effects on aggregate demand, thus weakening the policy's expansionary effect on real output.
D) have conflicting effects on aggregate demand, thus strengthening the policy's expansionary effect on real output.

Question

Quizplus · Accepted Answer

An expansionary monetary policy increases the money supply and lowers interest rates, which leads to increased investment and consumption spending. This increase in aggregate demand will shift the economy to a point on the production possibilities frontier that represents higher output. Since the economy is open and there is high capital mobility and floating exchange rates, the increase in demand will also lead to an increase in exports, which will cause an increase in the value of the currency. This increase in the currency value will make imports cheaper, which will further increase demand and strengthen the expansionary effect on real output.

Given an Open Economy with High Capital Mobility and Floating