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What happens when there is an expansionary monetary policy under a flexible exchange rate regime to...

What happens when there is an expansionary monetary policy under a flexible exchange rate regime to the exchange rate, interest rate, consumption, investment, and net exports? Be sure to include the IS-LM-UIP diagrams in your answer.

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Answer #1

Expansionary monetary policy stimulates aggregate demand by reducing rate of interest. This increases borrowings so consumption and investment rises. LM shifts right and income and interest rates are increased.

Now a lower interest rate is associated with Net capital outflow and a net exports. This occurs because NCO reduced demand for domestic currency so the exchange rate depreciates. This reduction in value of domestic currency is shown in the interest parity condition.

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