How might net exports affect expansionary fiscal and monetary policies in an open economy?

In an open economy, net exports, which are the value of a country's exports minus its imports, can significantly influence how expansionary fiscal and monetary policies function. When a government implements expansionary fiscal policy, such as increasing government spending or decreasing taxes, the intended outcome is to boost aggregate demand and stimulate economic growth. However, if the demand in the domestic economy increases significantly, this can lead to a rise in imports, as consumers and businesses buy more foreign goods and services. This increase in imports means that the positive effect of the fiscal policy on domestic production may be offset by rising trade deficits, effectively dampening the overall impact of the expansionary fiscal action.

On the other hand, expansionary monetary policy, which generally involves lowering interest rates to increase the money supply and encourage borrowing and spending, can lead to different outcomes. Lower interest rates can make domestic investments more attractive and depreciate the currency, enhancing the competitiveness of a country’s exports. Increased exports may result from more affordable domestic goods attracting foreign buyers, thereby enhancing the effectiveness of monetary policy.

Since net exports are likely to increase in response to expansionary monetary policy while potentially offsetting the effects of fiscal stimulus, the correct answer indicates that net exports may offset expansionary fiscal policy but enhance