i) What is a balance sheet recession? What factors make these recessions more difficult to recover from than normal recession? Illustrate a balance sheet recession in the 3- equation model. [8]

(ii) Explain the difference between the real exchange rate channel and the real interest rate channel. Which of these channels must dominate for the economy to revert to equilibrium after a shock without any active policy response? Use the three-equation model to illustrate your answer. [12]