The following question is based on fixed exchange rate and/or flexible exchange rate regime in an open macroeconomic model. The answers must be written in your words along with graphical illustration. Without explaining in your words, the graphical illustration alone will not be credible. Also make sure you use the relevant symbols and notation on each of the lines and axis on the graph(s) to clearly indicate the working mechanism of variables.

a. Suppose the domestic and foreign interest rates are both initially equal to 4%. Now suppose the foreign interest rate rises to 6%. Explain what effect this will have on the exchange rate. Also explain what must occur for the interest parity condition to be restored.

b. Assume the exchange rate is allowed to fluctuate freely. Using the IS-LM-IP model, graphically illustrate and explain what effect an increase in government spending will have on the domestic economy. In your graphs, clearly label all curves and equilibria.

c. Assume the exchange rate is allowed to fluctuate freely. Using the IS-LM-IP model, graphically illustrate and explain what effect expansionary monetary policy will have on the domestic economy. In your graphs, clearly label all curves and equilibria.

d. Assume that policy makers are pursuing a fixed exchange rate regime. Now suppose that the foreign interest rate falls. Discuss what policy makers must do to maintain the pegged exchange rate. Also discuss what effect this will have on domestic output and net exports.

e. Assume the exchange rate is fixed. Using the IS-LM model, graphically illustrate and explain what effect an increase in consumer confidence will have on the domestic economy. In your graphs, clearly label all curves and equilibria.