Part I: (8 points) Draw and label accurately the IS-LM-FX graphs in a and b. Starting with the economy in short-run equilibrium, and using the graph, show the effect of each change on equilibrium Y, i, and E and note the direction of change from one equilibrium to the next. Explain in a few sentences what happened in each instance.

a. Fixed exchange rate; increase in government spending

b. Flexible exchange rate; increase in money supply.

Part II: Define and explain the importance of 3 of the following concepts (12 points)

Sovereign Wealth Funds Liability Dollarization

Beggar-Thy-Neighbor Policy Original Sin

Part III: Essay Question (10 points)

Given your life experience working in the Gulf Region and using the knowledge gained from this class, explain the advantages and disadvantages for a small open economy such as the Kingdom of Bahrain to peg its currency to the US dollar. Are there any circumstances in which the Bahraini Dinar (and other Gulf countries) might abandon the peg and allow the currency to float against the US dollar? In your opinion, what would be the economic consequences of such a decision on the Bahraini economy?