Suppose the small open economy Iceland has perfect financial capital mobility and no risk premium. Some...
Suppose the small open economy Iceland has perfect financial capital mobility and no risk premium.
Some of their information is:
C = 150 + 0.60(Y – T) – 25r
I = 200 – 75r
d) Draw two diagrams depicting long-run equilibrium, one for the domestic loanable funds market in Iceland and one for the foreign exchange market. In each diagram clearly label the initial long-run equilibrium from part A/B & the both new long-run equilibria from part C. Has the domestic currency (DC) experienced a real appreciation or depreciation? Which fiscal policy change results in the largest real exchange rate fluctuation? Briefly explain why this is so.
(6 points)
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Suppose the small open economy Iceland has perfect financial
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