1. In the open economy, a higher real interest rate attracts foreign investment, which means foreign financial capital flows in.Suppose there is only one foreign country, please draw the graph andshow the changes in the foreign exchange market. Please explain the effect on the exchange rate and whether the domestic currency will appreciate or depreciate against the foreign currency.
2. If the effect on the exchange rate is long-term, what will happen to the net exports?Explain, in words, why an increase in government purchases may be desirable in the short run, but possibly undesirable for the economy in the long run.