Monetary and Fiscal Policy: Explain with the aid of diagrams, how an increase in Government spending...

Monetary and Fiscal Policy:

Explain with the aid of diagrams, how an increase in Government spending in a small open economy affects the Aggregate Demand curve:

a. Assuming a flexible exchange rate

b. Assuming a fixed exchange rate.

NO HANDWRITINGS PLEASE. I CAN'T READ MOST OF THE HANDWRITINGS, UNFORTUNATELY. THANKS IN ADVANCE FOR TYPING ANSWERS

Solutions

Expert Solution

ANSWER:

Here the rise in government spending will increase the government spending and hence that the real GDP and GNP will increase causing demand for getting money more therefore the interest rates will rise.

As result the home country will appreciate because of rising interest rate under floating exchange rate.

Then that foreign currency will be depreciate .

the graph is shown below

Suppose if the government increased spending the aggregate demand rises and hence that the rral output and Real gross density product (GDP) is increase because of higher consumption.

due to since exchange rate is fixed, This also raises gross national product (GNP) and hence money demand rises will causing interest rate to rise.

Then excess demand for a home country currency will thus be intervened by central bank by buying of foreign currency at fixed rate.

the graph is shown below

Rahul Sunny answered 1 year ago

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