this picture for Question a）and b）
Extra Final Exam study question on the OPEN ECONOMY
1. Foglandia is a major fog commodity exporting country. It is the major source of exports and government revenues. The world price of fog is denominated in Euros, €. The Central Bank operates a fixed nominal exchange rate regime. Assume that the economy is in a medium run equilibrium, net exports are zero, and the current budget deficit is zero. Prices and or inflation (expectations) in Europe and Foglandia are the same.
a) Show graphically the situation in Foglandia in the IS-LM-UIP space.
b) Why might Foglandia chosen to have a fixed exchange rate regime? What are the benefits and costs over a flexible regime?
c) The latest World Economic Outlook from the IMF projects a global economic slowdown. Show what happens to the Foglandia economy is the short-run. What happens to output, ue, the interest rate, exchange rate, relative prices/inflation, the exchange rate, net exports, and the government budget deficit?
d) What action(s) does the Central Bank actions need to take for maintaining the nominal exchange rate peg?
e) How might fiscal policy in response to the new equilibrium? Would you recommend the action – why or why not?
f) What would happen in the medium-run if there was no fiscal policy action and the Central Bank in the medium-run did not change the nominal exchange rate? Hint: Discuss the transition process from the short-run to the medium-run. e.g. what happens to the real and nominal exchange rate?
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