Fiscal Policy Under Fixed Exchange Rates
Posted by ivanckw at May 17th, 2007
When the exchange rate is fixed, the balance of payments surplus created by a stimulating dose of fiscal policy does not cause the exchange rate to rise. Instead, it causes an increase in the money supply as the Fed buys foreign currency (the balance of payments surplus) with dollars. This increase in the money supply augments the stimulating effect of the policy dose, making fiscal policy stronger in affecting the income level.
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