ere's an increase in Total Expenditures, therefore the IS curve shifts to the right and the economy goes from point A to point B. At B, there are infinite capital inflows as foreign investors seek to purchase higher returning domestic assets. These investors are exchanging their currency for the more desirable dollar. This increased demand for dollars causes the value of the dollar to rise on foreign exchange markets (i.e. the dollar appreciates, e decreases). As e decreases, Net Exports decrease as domestic goods become relatively more expensive on international markets. As NX decreases, Total Expenditures fall and the IS curve shifts to the left. The exchange rate will continue to appreciate, and the IS curve will continue to shift to the left until the capital inflow is halted (i.e. until the domestic interest rate equals the foreign interest rate). The new equilibrium is at the same level of output as the initial level: the economy moves back to A. Moral: Fiscal policy is ineffective in altering the level of domestic output under flexible exchange rates and perfect capital mobility.(Diagram 6, Appendix 1)Appendix 1Diagram 1Diagram 2Diagram 3Diagram 4Diagram 5Diagram 6 ...
