In a Small Open Economy with a Fixed Exchange Rate

Multiple Choice

In a small open economy with a fixed exchange rate, if the government increases government purchases, then in the process of adjusting to the new short-run equilibrium the money supply:

A) increases to keep the exchange rate unchanged, thus augmenting the effect of government spending on income.
B) decreases to keep the exchange rate unchanged, thus offsetting the effect of government spending on income.
C) remains unchanged, and there is no effect of government spending on income.
D) remains unchanged to keep the interest rate at the world interest rate, so that government spending reduces income.