The combination of the portfolio balance approach and the Mundell-Fleming model predicts that under conditions of high capital mobility, an expansionary fiscal policy will:

A. lead to currency appreciation in the short run, and currency depreciation in the long run.
B. lead to currency depreciation in the short run, and currency depreciation in the long run.
C. have an ambiguous impact on exchange rates in the short run.

Correct Answer: A

In the short run the currency will appreciate due to the increase in the real interest rate differential. In the long run the currency will depreciate because the central bank will monetize its debt or the government's fiscal stance will have to shift toward significant restraint.