In the New Keynesian Open Economy Model with a Fixed

Multiple Choice

In the New Keynesian open economy model with a fixed exchange rate, suppose that the output gap is initially zero and there is an increase in labour supply. What is the correct policy response to keep the output gap at zero?

A) Increase the money supply.
B) Reduce government spending.
C) Increase government spending.
D) Reduce the money supply.
E) Nothing.