Question

Which of the following could cause an appreciation of the real exchange rate in a small open economy? A decrease in the domestic interest rate. The expiration of an investment tax-credit provision. An increase in government spending. An increase in taxes.

Answer 1

Answer: An increase in government spending

Explanation:

Currency appreciation is an increase in the worth of one currency against the value of another currency. Due to the appreciation of a currency, imports get cheaper.

In a small open economy, the appreciation of the real exchange rate can be caused by an increase in government spending as this puts pressure on domestic currency to appreciate, which leads to current account deterioration.