The IS/LM/BP analysis suggests that, if the BP curve is steeper than the LM curve and The exchange rate is flexible, contractionary fiscal policy by country A will lead to __________ in country A's balance of payments and hence to __________ of A's
Currency relative to other currencies.

Question

Quizplus · Accepted Answer

C) an incipient surplus; an appreciationIn the IS/LM/BP model with a flexible exchange rate system, a contractionary fiscal policy (such as a decrease in government spending or an increase in taxes) typically leads to higher interest rates as the IS curve shifts to the left. If the BP curve is steeper than the LM curve, this implies that capital mobility is relatively high, and the interest rate increase makes domestic assets more attractive to foreign investors. This capital inflow improves the balance of payments, leading to an incipient surplus. As demand for the domestic currency increases to purchase domestic assets, the currency appreciates relative to other currencies.

The IS/LM/BP Analysis Suggests That, If the BP Curve Is