Question #2
Reading: Reading 5 Currency Exchange Rates - Understanding Equilibrium Value
PDF File: Reading 5 Currency Exchange Rates - Understanding Equilibrium Value.pdf
Page: 1
Status: Unattempted
Correct Answer: B
Question
Under the Mundell-Fleming model and the portfolio balance approach to exchange rate determination, a country following sustained expansionary fiscal policy would see its currency:
Answer Choices:
A. appreciate in the short-run and depreciate in the long-run
B. appreciate in the short-run and appreciate in the long-run
C. depreciate in the short-run and depreciate in the long-run
Explanation
Under Mundell-Fleming model, a country running expansionary fiscal policy (i.e., running
fiscal deficits) would attract foreign capital due to high interest rates and will see its
currency appreciate in the short-run. Under the asset market approach, in the long-run
sustained deficits will increase the risk of the country's debt and lead to a currency
depreciation.