Just a short note as a backgrounder for the current Canadian debate about fiscal policy.
This is totally unoriginal boring textbook stuff (at least I hope it is, anyway). Prerequisite: intermediate macro (or special permission to skip to the results if you promise not to ask me daft questions about where they came from).
The simple second year textbook Mundell-Fleming ISLMBP model under flexible exchange rates makes two assumptions that we need to modify:
1. The simple textbook version assumes the money supply is fixed. In other words, it assumes the Bank of Canada targets the money supply. But the Bank of Canada targets the inflation rate, and it adjusts the money supply (adjusts the nominal interest rate and allows the stock of money to adjust, if you prefer) to keep its internal forecast of the inflation rate at 2%. The easiest way to build this into the textbook picture is to assume the Bank of Canada shifts the LM curve to try to keep the ISLMBP equilibrium point at (what the Bank of Canada thinks is) potential output Y*.
2. The simple (or simplest) textbook version (normally) assumes the exchange rate is not expected to change. The expected rate of appreciation/depreciation is assumed to be zero, so the BP curve is horizontal at the exogenous world interest rate. But if the change in fiscal policy (e.g. an increase in Government expenditure) is temporary, the exchange rate will appreciate when G increases, and will depreciate again in future when G falls back to normal. And if the foreign exchange market is not "dumber than a sack of hammers" (in Stephen Gordon's unforgettable phrase) it might figure this out. If so, the expected exchange rate depreciation following the initial (surprise) appreciation will cause the BP curve to shift up. Canadian interest rates will rise relative to world interest rates, because the Looney is expected to be depreciating back to its original level. But if the change in fiscal policy is expected to be "permanent" (or at least be wound down slowly enough that this effect can be ignored) the BP curve will not shift up.
Permanent increase in G.
The increase in G causes the IS curve to shift right, which causes an incipient (lovely word) increase in the Canadian interest rate which causes an incipient excess demand for Looneys on the foreign exchange market, which causes an exchange rate appreciation which causes Net eXports to fall which causes the IS curve to shift left again to where it started. The Bank of Canada does nothing because it doesn't need to do anything.
TLDR: A "permanent" increase in G (or one that is expected to be unwound very slowly over time) causes an appreciation of the exchange rate and a fall in Net eXports equal to the rise in G, with no change in interest rates, output, inflation, whatever.
Temporary increase in G.
Same as before, the IS curve shifts right and the exchange rate appreciates. But this time the BP curve shifts up, because the exchange rate is expected to depreciate as the increase in G is unwound. If the Bank of Canada held the money supply constant (like in the textbook version) the Aggregate Demand curve would shift right, output would increase, and inflation would rise above the Bank's forecast target. So the Bank of Canada will decrease the money supply to shift the LM curve to the left to prevent this happening. This is called "monetary offset"; the Bank of Canada is in charge of the AD curve, and does what it needs to to shift the AD curve to where the Bank of Canada thinks (rightly or wrongly) it ought to be to keep future inflation at the 2% target.
TLDR: An increase in G that is expected to be temporary (unwound relatively quickly) will cause both an exchange rate appreciation and an increase in Canadian interest rates. The fall in Net eXports plus the fall in Investment and Consumption will equal the rise in Government expenditure. No change in output or inflation.
Bottom line: if (for some reason) you want temporarily higher Canadian (real and nominal) interest rates then you should ask for an increase in Government spending or Tax cut, but it should be very clearly announced that the higher deficit will be wound down quickly to 2x4 the foreign exchange market into figuring out that expected depreciation is a rational expectation. If the forex market doesn't get the message, or doesn't believe the message, it won't work.
[Of course, if you are a microeconomist, who doesn't understand all this macro cr*p, but reckons that low real interest rates raise the Net Present Value of some government investment projects, and makes some of them them now NPV > 0 in a standard micro Cost Benefit Analysis, then you go right ahead.]
P.S. I ignored Ricardian Equivalence, but if you did want to assume it: a permanent increase in G won't even change the exchange rate (unless the government has different preferences for domestic vs imported goods than the private sector); a temporary increase in G has roughly the same effects as what I said above regardless of whether Ricardian Equivalence is true (though smaller effects the longer it is expected to last), but temporary cuts in T don't matter at all.