1. A financial crisis is a form of a large, negative, temporary and demand shock in the money market such that money demand increases for a given level of money supply. Assume a flexible exchange rate regime.

a Use the IS-LM -FX model to illustrate the short-run effects of a financial crisis on output, nominal interest rate, exchange rate and investment.

b. Suppose the goal of macro policy is to stabilize output in the short run. What kind of fiscal policy would you recommend to the government?

c. Can we replace the fiscal policy in Part (b) with monetary policy? If you answer yes, explain what kind of fiscal policy is desirable. If you answer no, explain why.

d. Suppose that the central bank in this country switches to a fixed exchange rate regime. How will your answer in Part (c) change?

2. Consider the central bank's balance sheet under the international gold standard and that under the gold exchange standard in which the US was the anchor currency.

a Explain the impacts of Great Britain's trade surpluses on the Bank of England's balance sheet under the international gold standard.

b. Explain the impacts of Great Britain's trade surpluses on the Bank of England's balance sheet under the gold exchange standard.

c. Explain the impacts of the US trade surpluses on the Federal Reserve System's balance sheet under the gold exchange standard.