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Assume the small open economy starts from a position of a balanced trade. Giving reasons, clearly...

Assume the small open economy starts from a position of a balanced trade. Giving reasons, clearly explain what the effect of an expansionary fiscal policy abroad (by a large open economy) will be on the trade balance of a small open economy? You may need to draw diagrams to determine the effect. However, do not provide diagrams with the answer. (100 words maximum)

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Answer #1

The expansionary fiscal policy in the large foreign country would lead to the rise in the interest rate in the international market. thus there will be outflow of fund and investment will decline in the small open economy.

When there is outflow of fund, the exchange rate will fall and net export will rise in the economy. Thus , expansionary fiscal policy abroad is beneficial to the economy. The demand for country export would also rise due to the rise in the aggregate demand in the world economy.

following is the diagram:

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