Consider an open economy with a fixed exchange rate, a trade balance of zero but high involuntary unemployment. On the basis of the four-sector Keynesian income-expenditure model, a policy most likely to reduce the unemployment rate without leading to a trade account deficit would be

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Begin by restating the scenario and listing the options to analyze their potential effects in a four-sector Keynesian model with a fixed exchange rate, open economy, zero trade balance, and high involuntary unemployment.
Options:
- a devaluation of the exchange rate
- an expansionary monetary policy
- a revaluation of the exchange rate
- an expansionary fiscal policy
Option 1: a devaluation of the exchange rate
Devaluation typically lowers the real exchange rate, making exports more competitive and imports more expensive, which tends to improve the trade balance (to some extent) and can reduce unemployment through higher demand for domestically produced goods. However, in this question the trade balance is already zero and the concern is to avoid creating a trade account deficit. Devaluation would likely affect the current account positively rather than cause a deficit, so it doesn’t align with the aim of avoiding a deficit while reducing unemployment. Moreover, if there is high involuntary unemployment, the question’s setup usually expects a policy tool that stimulates domestic demand without worsening the trade balance constraint under fixed rates.
Option 2: an expansionary monetary policy
Under a fixed exchange rate with high capital mobility, expansionary monetary policy (lower interest rates) is constrained. To maintain a fixed rate, the central bank must intervene by buying foreign reserves, which expands the monetary base but does not reliably translate into a sustained rise in output or employment; in many Mundell-Fleming-style analyses, monetary expansion is largely ineffective for boosting real GDP under fixed rates with perfect capital mobility, and it risks altering the exchange rate unless sterilized. Even when it does raise money supply temporarily, the fixed-rate regime tends to offset its effect on employment through the balance of payments process, making it unlikely to reduce unemployment without triggering other imbalances.
Option 3: a revaluation of the exchange rate
Revaluation (an appreciation) would make imports cheaper and exports less competitive, generally worsening the trade balance and potentially increasing unemployment in the tradables sector. Since the goal is to reduce unemployment without creating a trade account deficit, a revaluation is unlikely to deliver the desired employment gains and would instead likely tighten domestic demand for traded goods, making it a poor fit for the objective.
Option 4: an expansionary fiscal policy
An expansionary fiscal policy (higher government spending or lower taxes) directly boosts aggregate demand. In a four-sector Keynesian framework with a fixed exchange rate, this policy can raise output and employment by stimulating domestic demand for goods and services. Although higher income may increase imports, under certain conditions and with fixed exchange rates, the policy can still reduce unemployment more reliably than monetary tools, and the problem’s phrasing emphasizes finding a policy that reduces unemployment while avoiding a trade account deficit. Fiscal expansion tends to be the most straightforward demand-side stimulus that boosts domestic production, with the balance of payments effects depending on the capital account and automatic stabilizers.
In summary, while each option has trade-offs, the expansionary fiscal policy is the one most aligned with increasing domestic output and employment without relying on exchange-rate changes, making it the best fit among the given choices for reducing unemployment under the stated constraints.

ECOS2002 (ND) Early Feedback Task: Quiz 1

Consider an open economy with a fixed exchange rate, a trade balance of zero but high involuntary unemployment. On the basis of the four-sector Keynesian income-expenditure model, a policy most likely to reduce the unemployment rate without leading to a trade account deficit would be

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