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

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In a fixed exchange rate system with no sterilization, the exchange rate is fixed, so the foreign exchange (FE) curve is a horizontal line. A negative domestic spending shock shifts the IS curve to the left, which lowers domestic income and reduces imports. This creates a balance of payments surplus, which puts upward pressure on the exchange rate and causes the central bank to intervene by selling domestic currency and buying foreign currency to maintain the fixed exchange rate. As a result, the money supply contracts, shifting the LM curve to the left, which raises the domestic interest rate and further reduces domestic spending. If the FE curve is flatter than the LM curve, this means that a given change in the interest rate has a larger impact on the exchange rate, so the contractionary monetary policy required to defend the fixed exchange rate causes a larger reduction in output and a larger balance of payments deficit.

For a Country with a Fixed Exchange Rate and No