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

Question

Quizplus · Accepted Answer

A negative external capital-flow shock shifts the FE curve left, which increases the demand for domestic currency and leads to an incipient balance of payments deficit. Under zero sterilization, the money supply will stay the same, so there will be excess demand for money in the money market. As a result, interest rates will increase and the LM curve will shift left.

Assume That the FE Curve Is Flatter Than the LM