question 5 length guide about 2 pages including graphs consider a smal
Question 5 (length guide: about 2 pages including graphs)
Consider a small open economy with a flexible exchange rate.
(a) Write down the IS relation, the LM relation and the interest parity relation and explain
what they represent. Show them on a clearly labelled diagram(s). (5 marks)
Use the Mundell-Fleming model to predict the effects on output, the nominal exchange rate,
and the trade balance in each of the following cases:
(b) A monetary expansion where the central bank raises the interest rate temporarily. (5
(c) A temporary increase in consumer confidence where the central bank chooses to respond
to any possible inflationary pressure (hint: see how the central bank would adjust its policy
instrument). (5 marks)
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