Question 2. (20 marks)

Part a. (10 Marks) Use the Mundell-Fleming model to predict what would happen to aggregate income, the exchange rate, and the trade balance under both floating and fixed exchange rates in response to a tax cut by Govt. of Canada (Canada is a small open economy).

Part b. (10 Marks) Is the tax cut effective under floating exchange rate or fixed exchange rate regime? Why or why not?