For the following you will use the TWO GRAPHS WE HAVE DEVELOPED FOR THE SMALL OPEN ECONOMY (SOE): the graph that links domestic S and I to the global interest rate r*, and the graph that links the NX (X-M) demand function for the small open economy with the real exchange rate.

Okay, SEPARATELY FOR EACH SCENARIO BELOW, START from a position of TRADE ACCOUNT IN BALANCE, (X = M) for the SMALL OPEN ECONOMY.

Now, trace through the impact (using the two graphs for the SOE) for each of the following cases and show:

THE CHANGES IN THE SOE:

(1) to the NFI (net foreign investment - or net capital inflow or outflow)?

(2) to the position of the small open economy being a borrower or a lender in the international capital markets?

(3) to the trade balance (NX)?

(4) to what would you normally expect to occur to the relative price levels in the small open economy versus the ROW that would help explain the movements in the two graphs?

BON SUC * Trade Balance : S= 1=0 K=M O S = I S-1=0 71 NX S-1 NX $ 1:0 Balance * Trade Deficit: S S Somel capital outflow =0 X - M = S- I ro Nxu, e's I NX S- ISO =Refit Yis determined in RUN, Sot takes it Deficit supplies S-I70 S= Y-C-G 17 cucspending Couring is Net Bottower, Netlender = X-MPCIY-TIG Net capital inflow. Net capital Outflow =( 1-MPC)Y+ MPC (T-G) GV outflow so outflow 70 MPCV