Expansionary Fiscal Policy and Monetary under Floating Exchange Rate!
Under floating ER, the ER is allowed to fluctuate in response to changing economic conditions.
Expansionary fiscal policy although shifts IS curve to the right but Fiscal policy becomes ineffective in increasing the income level.
... CF will become negative. This will increase the demand for domestic currency in FOREX market
As a result, the value of domestic currency will thus rise.
Therefore, ER will appreciate.
Due to appreciation of ER, domestic goods will become expensive and foreign goods will become cheaper.
... NX will fall
Fall in NX offsets the expansionary effect of fiscal policy on income level.
... Income level will fall because Y = C + I + G + EX – IM.
Thus expansionary fiscal policy becomes ineffective in increasing the income level
Expansionary Monetary Policy under Floating Exchange Rate:
Increase in NX will lead to an increase in AD (because NX is a component of AD) and this will in turn lead to an increase in the income level from Y1 to Y2.