Question
Assume a small open country under fixed exchanges rate
and full capital mobility. Prices are fixed in the short run and equilibrium is given initially at point A. An exogenous increase in public spending shifts the IS curve to IS'. Which of the following statements is true?Solution
In the short run, output increases and so does money demand. The central bank must supply the money demanded at the prevailing interest rate i=i* . Since an autonomous monetary policy is not feasible, the TR curve is irrelevant.
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