Assume that policy makers are pursuing a fixed exchange rate regime. Assume that the economy is initially operating at the natural level (i.e., Y = Yn). Suppose fiscal policy makers increase government spending. This fiscal contraction will cause which of the following?

A) The real exchange rate will be permanently higher in the medium run.
B) The real exchange rate will be permanently lower in the medium run.
C) The effects of this devaluation on the real exchange rate will be ambiguous in the medium run.
D) The real exchange rate will be unchanged in the medium run.
E) none of the above

ANSWER:

B