Consider a small open economy with perfect capital mobility and a flexible exchange rate. Suppose that net capital outflow (NCO) is negative at the world interest rate. Use a two-panel diagram to explain the following. (Total marks = 20)

• What is the is the effect of an increase in world interest rate on (i) national saving, (ii) domestic investment, (iii) NCO, (iv) the real exchange rate, and (v) net exports? (5 marks)