Brazil is a small open economy (SOE) and an interest rate taker at r₁*. Suppose that the U.S., a large foreign country that has influence on the world financial market, pursue anexpansionaryfiscal policyby lowering net taxes.

Answer the following questions in this order.

What happens to theworld interest rate(r*)? Call it r₂*.

What happens to Brazil net capital flow? Is it anet capitalinfloworoutflow?Explain. Assume initially that in Brazil NCF = S₁- I(r₁*) = 0, the nominal exchange rate e = $US/Real, P^USand P^Brazilare fixed. Illustrate the impact of the foreign fiscal policy on the SOE's graph below.