AP Macroeconomics Question 21: Answer and Explanation

Test Information

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Question: 21

4. In what ways is contractionary fiscal policy in the United States likely to affect domestic interest rates and the international value of the dollar?

  • A. Interest rates increase and the dollar depreciates.
  • B. Interest rates decrease and the dollar appreciates.
  • C. Interest rates increase and the dollar appreciates.
  • D. Interest rates decrease and the dollar is not affected.
  • E. Interest rates decrease and the dollar depreciates.

Correct Answer: E

Explanation:

E Contractionary fiscal policy starts with the government decreasing its spending (or increasing taxes). As the government demand for loanable funds has decreased, the interest rate drops, leading to a decrease in demand of the domestic currency. Therefore the answer is (E).