Question

Rest of the world

In a small open economy, if the rest of the world engages in contractionary fiscal policy, then net capital outflows will ---- and the real exchange rate will ----.

A decrease; decrease

B decrease; increase

C increase; decrease

D increase; increase

Answer 1

In a small open economy, if the rest of the world engages in contractionary fiscal policy then the gdp in the other countries will decrease and to maintain balance in money market interest rates will fall in that country,

thus the people will the small economy wont transfer their money overseas and people from rest of the world transfer money in small economy due to higher rates thsu the demand for the currency of small economy rises and thus the currency of small economy appreciates,

so answer is b