True or False?
The statement is true. When the exchange rate is flexible, equilibrium in the small country occurs at the intersection of its LM curve with the real interest rate line. If the small country's central bank is well enough informed it can vary the nominal money supply to make LM pass through the intersection of the real interest rate line and the vertical full-employment output line at all times, regardless of changes in the world real interest rate. Of course, the small country's authorities are not likely to know the shape of the domestic LM curve and the amount it will shift in response to a given change in the domestic nominal money supply. So complete insulation from real shocks in the big country, as well as from demand for money shocks at home, is easier said than done.