For now, assume we are in a world where the only investment opportunity in any country is that country's government bonds and that the interest rate is set in the domestic money market (and is held constant below).

Say a new president is elected in the country Buff. Currently, it costs 2 blues (Buff's currency) to buy a US dollar. In her inaugural speech, the president denounces the previous government as extremely corrupt and says that much of the government debt issued came through illegal dealings between the previous president and foreign investment banks.

a. What will this do to the exchange rate (if anything) between Buff and the US ? Demonstrate what moves and explain why using our graphs. (you may want to use the equations we developed in class as well). [assume Buff is the home country]

Instead, say that in the inaugural speech, the president announces that the head of the Treasury (who has thus far steadfastly defended the 2 to 1 exchange rate) will be replaced with someone who has made a few comments that might imply he wouldn't mind seeing a depreciation.

b. What will this do to the exchange rate (if anything) between Buff and the US ? Demonstrate what moves and explain why using our graphs. (you may want to use the equations we developed in class as well). [assume Buff is the home country]