For a country with a fixed exchange rate and no sterilization: When the FE curve is steeper than the LM curve, a negative domestic spending shock to the IS curve creates a balance of payments surplus, which then causes the LM curve to shift to the right.

Question

Quizplus · Accepted Answer

When the FE curve is steeper than the LM curve, an negative domestic spending shock to the IS curve will cause a decrease in output and a decrease in imports. This leads to a balance of payments surplus, as exports remain steady. The surplus creates an excess supply of the domestic currency in the foreign exchange market, which will cause the exchange rate to appreciate. This appreciation of the currency will shift the LM curve to the right, increasing output and lowering interest rates.

For a Country with a Fixed Exchange Rate and No