1. a general tax cut under a regime of flexible exchange rates.
2. a general tariff increase under a regime of fixed exchange rates.
3. a monetary expansion under either fixed or flexible exchange rates.
4. an export subsidy under a regime of flexible exchange rates.
Choose the option above that is correct.
The correct option is 2. Equilibrium output is determined under flexible exchange rates by the intersection of the LM curve and the ZZ line with the IS curve shifting automatically on account of nominal exchange rate adjustments to pass through this LM-ZZ intersection. All policies that operate on the IS curve are thus ineffectual under flexible exchange rates. This eliminates options 1 and 4. Monetary expansion can increase employment by shifting LM to the right under flexible exchange rates, but it is ineffectual under fixed exchange rates. This eliminates option 3. Import taxes, export subsidies and general tax cuts and increases in government expenditures lead (under the usual Keynesian assumptions) to increases in domestic output under fixed exchange rates.