The following three equations describe the essential features of an open economy with fixed exchange rates, where the definitions , = y; - and , = , ' have been used. Goods market equilibrium: Short-run aggregate supply: Real exchange rate: , = B, (e - - ) +B,, +2, , = Y, +s, e = e- - (1) (2) (3) Note that the expected inflation rate is set equal to the foreign inflation rate. We now introduce a fiscal policy reaction function with an inside lag. You can think of this as reflecting either a lag in the availability of information or the time it takes for legislatures to initiate action following the availability of new information. Government reaction function: , =-a,-1, where a