Suppose that the world consists of only two countries, A and B, of relatively equal sizes. The world interest rate in such a model is some average of the autarkic (no trade) interest rates in each of the two countries.
a. Draw "parallel" loanable funds markets for the two countries and show the position of the world interest rate. (Hint: What relationship must exist between the NCOs of the two countries?)
b. Suppose country A enacts laws that induce people to save more. Show the effects of such laws on each country's domestic amounts saved and invested.
c. In the currency-exchange diagrams for both countries, show the effect of country A's savings policies on both countries' exchange rates and net exports.
Compare the effects of an aggregate-demand-induced recession with an aggregate-supply-induced recession. How would you recognize that a recession is induced by demand or supply? What policies would be appropriate in the first case and what in the second?