In a Small Open Economy with a Fixed Exchange Rate

question 113

Multiple Choice

In a small open economy with a fixed exchange rate, if the government increases government purchases, then in the process of adjusting to the new short-run equilibrium the money supply:

• A) increases to keep the exchange rate unchanged, thus augmenting the effect of government spending on income.
• B) decreases to keep the exchange rate unchanged, thus offsetting the effect of government spending on income.
• C) remains unchanged, and there is no effect of government spending on income.
• D) remains unchanged to keep the interest rate at the world interest rate, so that government spending reduces income.

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