Flexible exchange rates and foreign macroeconomic policy Consider an open economy with flexible exchange rates. Let IP stand for the (uncovered) interest parity condition.

a. In an IS-LM-IP diagram, show the effect of an increase in foreign output, Y*, on domestic output, Y. Explain in words. (4 marks)

b. In an IS-LM-IP diagram, show the effect of an increase in the foreign interest rate, i*, on domestic output, Y. Explain in words. (4 marks)

c. Given the discussion of the effects of fiscal policy in this chapter, what effect is a foreign fiscal expansion likely to have on foreign output, Y*, and on the foreign interest rate, i*? Given the discussion of the effects of monetary policy in this chapter, what effect is a foreign monetary expansion likely to have on Y* and i*? (4 marks)

d. Given your answers to parts (a), (b) and (c), how does a foreign fiscal expansion affect domestic output? How does a foreign monetary expansion affect domestic output? (Hint: One of these policies has an ambiguous effect on output.) (4 marks)