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Exhibit: Policies Influence Real Exchange Rate

-(Exhibit: Policies Influence Real Exchange Rate)Which of the graphs illustrates the impact on the real exchange rate of contractionary fiscal at home,in the basic version of the small open economy model?
A) (B) (
C) (
D) (

Question

Use the following to answer questions :
Exhibit: Policies Influence Real Exchange Rate
 
-(Exhibit: Policies Influence Real Exchange Rate)Which of the graphs illustrates the impact on the real exchange rate of contractionary fiscal at home,in the basic version of the small open economy model?
A) (B) (
C) (
D) (

Quizplus · Accepted Answer

In the basic version of the small open economy model, a contractionary fiscal policy at home reduces output and raises the real interest rate, leading to a depreciation of the real exchange rate. This is illustrated in graph (A), where a contractionary fiscal policy at home leads to a leftward shift in the IS curve, a rise in the domestic interest rate, a fall in output and a depreciation of the real exchange rate. Graph (B) shows the effect of a monetary contraction at home, while graphs (C) and (D) illustrate the impact of external shocks.

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