Hello Eveyone,
With flexible exchange rates , expansionary fiscal policy , if capital flows are relatively insensitive to interest rate differentials (which is rarely the case), the currency may actually depreciate as the increase in aggregate demand will worsen the trade balance (increase imports with no direct impact on exports).
As per the underline : If currency depreciate then it will increase the export?
With an expansionary fiscal policy people have more money to spend becuase of which imports increase which causes domestic currency to depreciate. We are trying to figure out what happens in the short term remember mundell-fleming model focuses on what happens to a curency in the short run,so intially it will depreciate.
Thanks for the reply buddy , but, What about the consideration of following?
(Less tax & high infrastruce development ) Expansionay Fiscal policy = Fiscal deficit
So, Govt will borrow money to fund the fiscal deficit , because of which interest will increase—capital inflow will increase—demand for doemstic currency will increase—domestic currency will appreciate.
Absolutely correct assuming high capital movility.
Yes, if the local currency depreciates, then buying goods and services from abroad gets relatively more expensive and exports become relatively more beneficial. So indeed, exports will increase. As you can see, the system has a mean reversion level which is the sustainable current account. Imports and exports can’t increase or decrease indefinetely, they eventually find equilibrium.
For example, if country XV has a severe trade balance deficit (imports are way higher than exports), the local currency is expected to depreciate. Maybe you can’t forecast the amount of exchange rate variation, but at least the direction of the movement !