Answer-In a small open economy with a floating exchange rate, the supply of real money balances is fixed an...

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As G increases, IS 1 shifts to IS 2 . At new equilibrium e, interest rate also increase and i gt i.  Here,2 things are happening  a there will now be capital inflow as a result capital Ac surplus  b Since, AD and Y increased, import demand will increase which will lead to current Ac deficit.  Since, the magnitude of Capital Ac surplus will be much higher than the magnitude of current Ac deficit there is BOP surplus. As a result domestic currency appreciates dd for rupee has increased.  As a result Exports decrease and Imports increase imports have become cheaper Net exports falls  IS shifts back to initial level and equilibrium in the goods market is restored.     In a small open economy with a floating exchange rate, the supply of real money balances is fixed and a rise in government spending raises the interest rate, so that income must rise to maintain equilibrium in the money market.

In a small open economy with a floating exchange rate, the supply of real money balances is fixed and a rise in government spending ______

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