Question

2 Explain why temporary and permanent fiscal expansions do not have different outcomes under fixed exchange rates, as they do under floating.

Answer 1

2)The temporary and permanent fiscal policies in the short run are the same.So the effects are the same in output and employment.The output will increase since both AA and DD will shift to the right.However in the long run , the temporay fiscal expansions will become zero due to the temporary feature. AA /DD will move back to the original position.It is assumed that there is full employment in the economy.

For permanent fiscal expansion,as the output after  short run adjustment was higher than full employment ,the domestic price will rise and the AA/DD will shift to original position ie full employment position.So both policies do not have different effects under fixed exchange rate.