The RBI/Government is considering two alternative policy options under the two alternative exchange

rate regimes

Option 1: Allowing the interest rate to adjust and not the money supply

Option 2. Allowing the money supply to adjust and not the interest rate.

. Regime 1: Perfect capital mobility with fixed exchange Regime 2 Perfect capital mobility with flexible exchange rates.

rates.

Using the IS - LM model for an open economy, argue using two separate diagrams which possible policy combination (e. option + regime) is suitable as means for stabilizing output when the economy witnesses the following shocks

Shock 1: Following the threats to national security, the government increases defence expenditure. Shock 2: During the festive season, people are doing more transactions

Be sure to label your diagrams appropriately