AP Macroeconomics Question 21: Answer and Explanation
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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
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).