2.1. In recent years, many developing countries have been adversely affected by the threat of higher interest rates in the United States and other OECD countries. Using the Mundell-

Fleming model, explain why these adverse effects can arise, and how developing countries can best respond. (6)

2.2. Explain why a cut in government spending has a larger effect under a fixed exchange rate system and perfect capital mobility than in a closed economy model. (6)

2.3. Briefly explain why the current account is an important macroeconomic indicator. Should governments be concerned about a current account deficit, and if so why? (4)

2.4. Explain fully how a real depreciation affects output. (6)

2.5. Explain the effects in a small open economy of a fiscal contraction on income and the trade balance under the following.

2.5.1. A floating exchange rate. (4)

2.5.2. A fixed exchange rate. (4)

2.6. Explain fully how a real depreciation affects output. (6)

2.7. Explain briefly why a monetary contraction for a small open economy under fixed exchange rates will have no effect on real income. (4)

QUESTION 3 (10 MARKS)

Explain why each of the following statements is True, False, or Uncertain according to the economic theory you have learned. A few lines of explanation should be sufficient. Unsupported answers will receive no marks. It is the explanation that is important.

3.1. In a closed economy an increase in government spending increases the rate of economic growth in the long run. (3)

3.2. Both long-and short-run economic growth are determined by the same set of considerations. (4)