Assume That Policy Makers Are Pursuing a Fixed Exchange Rate

Multiple Choice

Assume that policy makers are pursuing a fixed exchange rate regime. Assume that the economy is initially operating at the natural level of output. Suppose that government spending decreases. Given this information, we know that this fiscal contraction will cause:

A) the real exchange rate to be unchanged in the medium run.
B) the real exchange rate only decreases in the medium run if foreign prices rise.
C) the real exchange rate to be permanently higher in the medium run.
D) the effects of this fiscal contraction on the real exchange rate will be ambiguous in the medium run.
E) the real exchange rate to be permanently lower in the medium run.