Assume a country faces a large government budget deficit and large current account deficit. Investors become concerned that the government will default on their foreign sovereign debt. As a result, they begin a large sell-off of their government bonds and take their funds out of the country.

1.What type of crisis is this? Explain the type(s) of crisis, the related vulnerabilities, and what triggered the crisis. (5 points)

2.Using the graph template, illustrate this chain of events. (18 points)

3.What happens to (increase/decrease or appreciate/depreciate): (7 points)

a.Real GDP

b.Employment

c.Price level

d.Government budget balance

e.Interest rate

f.Exchange rate

g.Current account

4.Describe one policy the government could have used to prevent the crisis, explaining how it would have limited the country's vulnerability to a crisis. (5 points)

AD-AS P AS Po AD Real GDP Money Market Ms io MD Mo M Foreign Currency Market R Ro QFC O