Question

Explain whether expansionary fiscal policy and whether expansionary monetary policy will crowd out net exports in a flexible exchange rate regime. Assume that the country in question is a small country ( there is perfect capital mobility).

Answer 1

Net exports will be crowded out in a situation when there is an inflow of funds in the economy and the local currency appreciates.

IF the country uses the fiscal expansionary fiscal policy then, in that case, the interest rates in the nation will rise and the perfect capital mobility will attract the global investment and appreciate the local currency. At a higher currency rate, the nation's export will become costlier and reduce.

IN case of a monetary expansionary policy, the increased supply of money will depreciate the currency rates as compared to other currency around the world. This will increase the exports of the local product will be cheaper at a depreciated rates.

The answer is Expansionary fiscal policy will crowd out the exports of the nation.