First, we assume we are in a fixed exchange rate mechanism. In this system, I deduce that the expected exchange rate would be fixed, at the market rate.

In a floating system, with open capital markets, when the expected exchange rate changed, or the foreign interest rate changed, the uncovered interest parity (UIP approx. version: $i_H=i_F+\frac{E^e-E}{E}$) would shift the IS curve accordingly. If the expected exchange rate rises ($E^e$ increases), or the foreign interest rate ($i_F$) rises, then we would have a shift of the IS curve by means of the current exchange rate $E$.

However, in a fixed exchange rate system, where $E^e=E$ (and hence $i_H=i_F$), is there a shift in IS when the foreign interest rate changes?

I ask this, because in chapter 18, and 19 of Feenstra and Taylor book, some 'examples' of fixed exchange rate systems with shifts in the IS curve due to changes in the foreign interest rate are given... But they don't explain how they are possible.


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