Question

Contrast the effectiveness of fiscal policy in an open economy versus a closed economy. In which case is fiscal policy less effective? Explain your answer.

Answer 1

Fiscal policy in open market affects the exchange rate and trade balance. In fiscal expansion the rise in interest rate due to government borrowing attracts foriegn market. In order to buy capital in dollars the price of dollar rises which creates exchange rate appreciation.

In closed economy the fiscal policy will drive up the interest rates. This would reduce both residential and non residential investment in the country And reduce interest rate Forms of consumption.

In both cases fiscal policy is less effective from above explanations.