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if exchange rates are fixed and the country experiences a recession, what would the government have...

if exchange rates are fixed and the country experiences a recession, what would the government have to do in order to keep the exchange rate at the stated peg? Describe the policy and draw a graph.

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Answer #1

1. Fiscal stimulus (increase spending; lower taxes increases aggregate demand (shifts DD to right)

2. But this causes initial appreci ation (fall in E); equil is at 2.

3. To protect the peg, CB must buy foreign assets with home currency. This increases the domestic money supply, which moves economy to final equil 3 (higher output)

4. Fiscal policy is potent because it causes both the DD and the AA schedules to shift

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