Consider a small open economy with a perfectly elastic supply of savings at interest rate r*, which is below the interest rate that would have prevailed in the economy if it could not have borrowed, and a normal investment curve. Show the market equilibrium, including the magnitude of foreign borrowing.
a. Now show the effect of an increased budget deficit.
b. Show the effect of an increased budget deficit that originates as a result of increased public investment, in which the public investment is a complement to private investment.