Question

The IS/LM/BP analysis suggests that, under flexible exchange rates,

Select one:

a. monetary policy is less powerful for affecting national income than under fixed exchange rates.

b. a country may have difficulty in staying on the LM curve.

c. expansionary fiscal policy may, in theory, cause either depreciation or appreciation of the home currency.

d. expansionary fiscal policy will always lead to a decline in national income.

Answer 1

Assuming perfect capital mobility,

According to the unholy trinity, there can't be any possibility of the simultaneous existence of stable exchange rate, effective monetary policy & perfect capital mobility.

since it is given that the exchange rate is flexible => Monetary policy is more effective than the fixed exchange rate. Hence A cannot be the answer.

Since expansionary fiscal will shift the IS rightward in the short run which lead to rise in the interest rate and appreciation causes price of imports to fall down and hence the imports will increase in the long run and the IS will shift back to its original position in the long- run. hence national income will not be change. Hence B cannot be the answer.  

B also cannot be the answer.

Since in the short run interest rate rises due to expansionary policy which lead to a rise in the capital inflow & hence there will be an appreciation of the domestic currency. Hence C will be the answer.