Assume that the FE curve is flatter than the LM curve. A negative internal shock shifts the IS curve leftward. Under zero sterilization, which one of the following will happen next?
A)Because of the incipient balance of payments deficit, the LM curve will shift leftward
B)Because of the incipient balance of payments surplus, the LM curve will shift rightward
C)Because of the incipient balance of payments deficit, the IS curve will shift leftward
D)Because of the incipient balance of payments surplus, the IS curve will shift rightward

Question

Quizplus · Accepted Answer

When a negative internal shock shifts the IS curve leftward, it leads to a decrease in income and interest rates, causing a balance of payments deficit. Under zero sterilization, the central bank does not intervene to offset the effects of this deficit on the money supply. Consequently, the money supply decreases, leading to an upward shift in the LM curve, which is represented as a leftward shift in the context of the IS-LM model.

Assume That the FE Curve Is Flatter Than the LM