Implications of exchange rate regime choice: Use the IS–LM–FX model to illustrate how and increase in income tax rates in the foreign country affects the home country. Show the IS-LM diagram for the home country and the FX market diagram. Compare the outcome when the home country has a fixed exchange rate with the outcome when the home currency floats. In the graph denote the initial equilibrium A, the outcome with a floating exchange rate B and the outcome with a fixed exchange rate C. Explain the changes and policies verbally and provide which domestic policies could the country implement to return to its original output level (the one before the foreign tax increase) while holding the exchange rate fixed? Provide at least two policy options.
Implications of exchange rate regime choice: Use the IS–LM–FX model to illustrate how and increase in income tax rates in the foreign country affects the home country. Show the IS-LM diagram for the home country and the FX market diagram. Compare the outcome when the home country has a fixed exchange rate with the outcome when the home currency floats. In the graph denote the initial equilibrium A, the outcome with a floating exchange rate B and the outcome with a fixed exchange rate C. Explain the changes and policies verbally and provide which domestic policies could the country implement to return to its original output level (the one before the foreign tax increase) while holding the exchange rate fixed? Provide at least two policy options.
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