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Exhibit: IS*-LM*
-(Exhibit: IS*-LM*) A small open economy with a floating exchange rate is initially at equilibrium A with IS*₁, LM*₁, equilibrium exchange rate e₂, and equilibrium output Y₁. If there is an increase in government spending to IS*₂, the new equilibrium will be at ____, holding everything else constant.

Question

Use the following to answer questions :
Exhibit: IS*-LM*

-(Exhibit: IS*-LM*) A small open economy with a floating exchange rate is initially at equilibrium A with IS*₁, LM*₁, equilibrium exchange rate e₂, and equilibrium output Y₁. If there is an increase in government spending to IS*₂, the new equilibrium will be at ____, holding everything else constant.

Quizplus · Accepted Answer

An increase in government spending will shift the IS curve to the right, causing the new equilibrium to be at point B. The increase in government spending will increase output and cause an increase in the interest rate, which in turn will cause the exchange rate to appreciate. The new equilibrium is at point B where the IS curve intersects the LM curve at the new higher interest rate and the new higher exchange rate.

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