Suppose that Canada decides to peg its dollar ($C, or the loonie) to the U.S. dollar at an exchange rate of $C1 = $US1. What is likely to happen to U.S. GDP following the leftward shift of its IS curve?
A) It will rise.
B) It will fall.
C) It will not change.
D) It will rise dramatically.

Question

Quizplus · Accepted Answer

If Canada decides to peg its currency to the U.S. dollar, it will fix the exchange rate between the two currencies. This means that any disturbance in the Canadian economy, such as a recession or low inflation, will affect the U.S. economy as well. Therefore, the leftward shift of the IS curve in Canada will lead to a decrease in demand for U.S. goods and services, causing a fall in U.S. GDP.

Suppose That Canada Decides to Peg Its Dollar ($C, or the Loonie)