In an open economy with fixed exchange rates, expansionary fiscal policy causes:
A) interest rates to rise and an inflow of foreign capital causing the government to intervene and buy foreign currency.
B) interest rates to fall and an inflow of foreign capital causing the government to intervene and buy foreign currency.
C) interest rates to rise and an outflow of foreign capital causing the government to intervene and sell foreign currency.
D) interest rates to fall and an outflow of foreign capital causing the government to intervene and buy foreign currency.
E) interest rates to remain unchanged with an outflow of foreign capital causing the government to intervene and sell foreign currency.

Question

Quizplus · Accepted Answer

In an open economy with fixed exchange rates, expansionary fiscal policy typically leads to higher interest rates as the government borrows more. This attracts foreign capital, increasing the demand for the domestic currency. To maintain the fixed exchange rate, the government must intervene by buying foreign currency, which corresponds to option A.

In an Open Economy with Fixed Exchange Rates, Expansionary Fiscal