1. Our model takes the price level P as given in the short run, but in reality the currency appreciation caused by a permanent fiscal expansion might cause P to fall a bit by lowering some import prices. If P can fall slightly as a result of a permanent fiscal ex- pansion, is it still true that there are no output effects? (As above, assume an initial long-run equilibrium.)

2- Suppose that interest parity does not hold exactly, but that the true relationship is R = R* + (Ee - E)/E + r, where r is a term measuring the differential riskiness of domestic versus foreign deposits. Suppose a permanent rise in domestic government spending, by creating the prospect of future government deficits, also raises r, that is, makes domestic currency deposits more risky. Evaluate the policy's output effects in this situation.