a. Suppose that governments around the world begin to engage in expansionary fiscal policy (run large budget deficits) in order to stimulate economic activity in their countries. Use the long-run model of a small open economy to illustrate graphically the impact of this expansionary fiscal policy by foreigners on the U.S. exchange rate and the trade balance. Assume that the country starts from a position of trade balance, i.e., exports equal imports. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the new long-run equilibrium values.

b. Based on your graphical analysis, explain the predicted impact of the foreign expansionary fiscal policy on the U.S. exchange rate and the U.S. trade balance.