Which of the following policies tends to cause the dollar to appreciate?Group of answer choicesan expansionary monetary policyan expansionary fiscal policya contractionary fiscal policya combination of an expansionary monetary policy and a contractionary fiscal policy
Question
Which of the following policies tends to cause the dollar to appreciate?Group of answer choicesan expansionary monetary policyan expansionary fiscal policya contractionary fiscal policya combination of an expansionary monetary policy and a contractionary fiscal policy
Solution
A contractionary fiscal policy tends to cause the dollar to appreciate.
Here's why:
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A contractionary fiscal policy involves increasing taxes and decreasing government spending. This reduces the overall demand in the economy, leading to a decrease in inflation.
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With lower inflation, the value of the dollar increases because each dollar can now buy more goods and services than before.
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Additionally, lower inflation can make a country's bonds more attractive to foreign investors because the real (inflation-adjusted) return on these bonds is higher.
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As foreign investors buy more of these bonds, they increase the demand for the dollar, causing it to appreciate.
So, in summary, a contractionary fiscal policy can cause the dollar to appreciate due to lower inflation and increased foreign demand for the country's bonds.
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