If the Bank of Canada allows the exchange rate to vary freely, which of the following effects will an expansionary fiscal policy have?

Question

Quizplus · Accepted Answer

When the Bank of Canada allows the exchange rate to vary freely, an expansionary fiscal policy will lead to a temporary increase in AD due to higher government spending and lower taxes. However, the increase in demand will eventually lead to a higher price level and higher interest rates, which will reduce demand for Canadian goods and services and shift the AD curve back to its original position. Therefore, the expansionary fiscal policy will have no permanent effect on the position of the AD curve or the interest rate.

If the Bank of Canada Allows the Exchange Rate to Vary