Monetary policy is highly effective in this case. In terms of Figure 11.4, an increase in domestic credit shifts the LM curve in panel

(a) from LM(M o) to LM(M1 ) and the LL curve from LL(M0) to LL(M1 ). At point e' the domestic interest rate is below the world interest rate, and a massive capital outflow occurs. There is excess demand for foreign exchange which leads to an instantaneous depreciation of the domestic currency (from E0 to E1 in panel (b)). This stimulates net exports as domestic goods are now cheaper to foreigners and shifts the IS curve from IS(E0) to IS(E 1 ). The new equilibrium, which is attained instantaneously, is at point el where output is increased.