1. bigger in the case of monetary policy than it would be if other countries keep their exchange rates constant.
2. smaller in the case of monetary policy than it would be if other countries keep their exchange rates constant.
3. the same in the case of fiscal policy as it would be if other countries keep their exchange rates constant.
4. bigger in the case of fiscal policy than it would be if other countries keep their exchange rates constant.
Choose the correct option.
Option 1 is the correct choice. A positive monetary shock in the big country will create a positive excess supply of money in the home economy. When other countries let their exchange rates float, this will cause the big country's currency to depreciate. The effect will be further expand its output and employment. A positive fiscal shock in the big country produces a domestic excess demand for money which will cause the home currency to appreciate if other countries hold their money supplies constant. This will dampen the effect of the fiscal shock on the big country's output and employment. These exchange rate effects come on top of the direct effects that accompany the change in the world interest rate, making the overall effect larger in the case of monetary policy and smaller in the case of fiscal policy.