PROBLEM SET #2 True, False or Uncertain: Explain In an open

1. True, False or Uncertain: Explain
In an open economy DD-AA model, a permanent increase in domestic
government purchases leads to an increase in domestic equilibrium interest rate
and output, and results into a depreciation of domestic currency against foreign
currency in the short run. [Diagram required]
Under flexible exchange rates, monetary expansion causes the current account
balance to increase in the short run.
Both the temporary and permanent expansionary fiscal policy improves the current
account balance. [Diagrams required]
If the economy, which is under a flexible exchange rate system, starts at longrun equilibrium, a permanent tax cut will cause its currency to appreciate but
will have no effect on output in the short-run. [Diagram required]
Explain how does an increase in the real exchange rate affect exports and imports?
Imagine that the economy is at a point on the DD-AA schedule that is above both AA and
DD and where both the output and asset markets are out of equilibrium and Y is less than
equilibrium output. Explain what will happen next and how the economy gets to
equilibrium in both markets?
Using a figure show that under full employment, a temporary fiscal expansion would
increase output (over-employment) but cannot increase output in the long run, under
flexible exchange rates