FRQ 2

1. Assume that the country of Rankinland is currently in recession.

(a) Assume that Rankinland produces only food and clothing. Draw a correctly labeled production possibilities curve for Rankinland. Show a point that could represent the current output combination and label it Point A.

(b) Assume that the Central Bank of Rankinland pursues an expansionary monetary policy.

(i) Identify the open-market operation that the Central Bank would use.

(ii) Draw a correctly labeled money market graph and show the short-run effect of the expansionary monetary policy on the nominal interest rate.

(iii) Assuming no change to the price level, what happens to the real interest rate as a result of the expansionary monetary policy? Explain.

(iv) Given your answer to part (b)(iii) regarding the real interest rate, what happens to the real gross domestic product (GDP) in the short run? Explain.

(c) Suppose Rankinland has a current account deficit. Rankinland's currency is called the bera.

(i) What will initially happen to the current account deficit in Rankinland solely due to the change in the real GDP from part (b)(iv)? Explain.

(ii) What will happen to the international value of the bera solely due to the change in the real GDP from part (b)(iv)? Explain.