5. (23 pts)) Figure 1 plots fictional time-series data for two countries. Country A (left), which is a closed economy, and Country B (right), which is an open economy. Both countries had a government balanced budget (neither a deficit nor a surplus) from time t=0 until t = 4. At time t = 5 both countries changed their fiscal policy in the exact same way. This you can see from the two top panels. Please answer the following questions: a) Looking at the top panel only, did the two countries engage in expansionary or contractionary fiscal policy from time t = 5? Explain. b) Name two policies that could have been implemented to achieve the expansionary/contractionary pattern depicted in the top panels. Mention real life situations that would justify the policies. c) Draw a graph that relates a country's interest rate to the amount of loanable funds. Using a supply and demand curve, indicate the equilibrium interest rate that prevails in both countries until time t = 4. d) Looking at the graph for Country A's interest rate, how can the pattern in the graph be described using your simple framework from part (c)? To answer this question, extend the graph you drew in (c) (using a different color or line style). Provide a short description that relates your graph to the graph of Figure 1. e) Provide a verbal argument on why we see a different evolution of interest rates in Country B. f) Draw another graph that pins down the equilibrium exchange rate of the two countries between time t 1 and t = 4 as determined by demand and supply of foreign exchange. g By extending the graph of part (f), try to explain the fall of the exchange rate for Country B from t=5 onward. Explain the underlying market force in a few words. h If trade was initially balanced up until time t = 4, does Country B have a current account surplus or deficit after the introduction of the fiscal policy? Explain. exchange rate (XR) budget balance (%GDP) interest rate (i) 2 9 - 0246 ap Country A 1 2 3 4 5 6 7 time (t) 2 4 time (t) 0.8 0.6 0.4 2 6 time (t) 6 exchange rate (XR) interest rate (i) budget balance (%GDP) 2 + 6 02448p 0.8 0.6 90 Country B 1 2 3 4 5 6 7 time (t) 2 4 time (t) 0.4 2 time (t) Figure 1: Fictional time series data on government budget balance (top panel), interest rates (middle panel), and exchange rates (bottom panel) for two countries - a closed economy (Country A, left column) and an open economy (Country B, right column)