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?
    A Point B can only be reached in the absence of capital mobility Correct Answer Incorrect Answer
    B A new equilibrium is reached at point C. Correct Answer Incorrect Answer
    C A new equilibrium is reached at point B Correct Answer Incorrect Answer
    D The TR curve will shift down until it passes through point B. Correct Answer Incorrect Answer

    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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