The LM* curve represents the relationship between interest rates and output in the foreign exchange market. When the central bank of a large open economy with a floating exchange rate increases its interest rate, the LM* curve shifts to the right. This is because higher interest rates attract more foreign capital, increasing the demand for the domestic currency.

The impact on the exchange rate is that it appreciates. An appreciation of the exchange rate means that the domestic currency becomes more valuable compared to foreign currencies. This happens because higher interest rates attract foreign investors who need the domestic currency to invest, increasing the demand for the domestic currency.

The impact on net capital flows is that they increase. Higher interest rates make domestic assets more attractive to foreign investors, leading to an inflow of capital. This is known as a capital inflow. At the same time, domestic investors are less likely to invest abroad because they can get a better return at home, leading to a decrease in capital outflow. The net effect is an increase in net capital flows.

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The LM* curve represents the relationship between interest rates and output in the foreign exchange market. When the central bank of a large open economy with a floating exchange rate increases its interest rate, the LM* curve shifts to the right. This is because higher interest rates attract more foreign capital, increasing the demand for the domestic currency.

The impact on the exchange rate is that it appreciates. An appreciation of the exchange rate means that the domestic currency becomes more valuable compared to foreign currencies. This happens because higher interest rates attract foreign investors who need the domestic currency to invest, increasing the demand for the domestic currency.

The impact on net capital flows is that they increase. Higher interest rates make domestic assets more attractive to foreign investors, leading to an inflow of capital. This is known as a capital inflow. At the same time, domestic investors are less likely to invest abroad because they can get a better return at home, leading to a decrease in capital outflow. The net effect is an increase in net capital flows.

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The LM* curve represents the relationship between interest rates and output in the foreign exchange market. When the central bank of a large open economy with a floating exchange rate increases its interest rate, the LM* curve shifts to the right. This is because higher interest rates attract more foreign capital, increasing the demand for the domestic currency.

The impact on the exchange rate is that it appreciates. An appreciation of the exchange rate means that the domestic currency becomes more valuable compared to foreign currencies. This happens because higher interest rates attract foreign investors who need the domestic currency to invest, increasing the demand for the domestic currency.

The impact on net capital flows is that they increase. Higher interest rates make domestic assets more attractive to foreign investors, leading to an inflow of capital. This is known as a capital inflow. At the same time, domestic investors are less likely to invest abroad because they can get a better return at home, leading to a decrease in capital outflow. The net effect is an increase in net capital flows.

Suppose the central bank of a large open economy with a floating exchange rate increases its interest rate. In the new short-run equilibrium, how does the LM* curve shift and what is the impact on the exchange rate and net capital flows?

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