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Consider a small open economy described by the AA-DD model. Add a default premium to the model, so domestic interest rate equals the world interest

Consider a small open economy described by the AA-DD model. Add a default premium to the model, so domestic interest rate equals the world interest rate plus a default premium R = R* + .

Can someone explain to me how the economy adjusts back over time to Yf if there is no policy response? Is there any downside with this to-do-nothing option and how the govt can act differntly? Many thanks!

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