True or False?
The answer is True. Suppose the exchange rate is fixed. Then a fiscal expansion to shift IS to cross ZZ at the full-employment level of output can be accompanied by a corresponding purchase of bonds by the central bank to increase the money supply until LM also crosses ZZ at the full-employment level of output. If the exchange rate is flexible that same increase in the money supply will shift the LM curve to pass through ZZ at full-employment. The previous dose of fiscal policy can then be applied to shift IS to pass through this LM-ZZ intersection. Since domestic residents will be in portfolio equilibrium at that level of output there will be no pressure on the nominal and real exchange rates.