What are the effects of an expansionary monetary policy on interest rates and output in an open economy with fixed exchange rates?

What will be an ideal response?

With an expansionary monetary policy in an open economy with fixed exchange rates, so long as the real interest rate can still go lower, the MP curve shifts down, which leads to a higher output gap and decreases the real interest rate. The lower real interest rate makes investment less attractive in the United States, so net capital outflows increase. The dollar depreciates in value, and net exports and output increase. If the real interest rate can not go any lower, then the downward shift of the MP curve will not change the output gap or capital flows. In this case, expansionary monetary policy will not be effective in stimulating the economy and increasing real GDP.