For this question,assume that policy makers are pursuing a fixed exchange rate regime.Now suppose a budget is passed that calls for a reduction in government spending.This reduction in government spending will cause which of the following to occur?
A)a reduction in i and an increase in E
B)a reduction in investment
C)no change in output
D)no change in net exports
E) an increase in imports

Question

Quizplus · Accepted Answer

A reduction in government spending would likely lead to a decrease in investment as the government is a significant source of demand in the economy. This decrease in investment could lead to a decrease in output as well. However, the fixed exchange rate regime means that the exchange rate must remain stable, so there cannot be an increase in E or a decrease in net exports (which would require an exchange rate depreciation). An increase in imports is also unlikely since a reduction in government spending would likely lead to a decrease in overall demand in the economy.

For This Question,assume That Policy Makers Are Pursuing a Fixed