Question

In: Economics

After a temporary fiscal expansion, will a floating exchange appreciate or depreciate? Explain

After a temporary fiscal expansion, will a floating exchange appreciate or depreciate? Explain

Solutions

Expert Solution

Since when there is appreciation of any domestic currency, then the domestic currency can buy more of foreign currency with the same domestic currency and it means domestic currency has got strength against the foreign currency.

Since when there is depreciation of any domestic currency, then the domestic currency can buy less foreign currency with the same domestic currency and it means domestic currency has become weaker against the foreign currency.

When there is a temporary fiscal expansion, then aggregate demand will increase, so the AD curve shifts rightward. So price level will increase and the real GDP will also increase. Hence domestic goods and services have become expansive relative to the foreign goods and services. So export decreases and import increases. Hence net export decreases, so demand for foreign currency will increase. Hence domestic currency depreciates and foreign currency appreciates. Hence exchange rate will appreciate.


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