Question 2. A country has a fixed exchange rate and capital is very mobile. Because it is experiencing high unemployment, the central bank increases the money supply. Using symbols and words, explain what will happen to (a) internal balance; (b) external balance; (c) the country's exchange rate.

How must the central bank respond if it wishes to maintain the fixed exchange rate?

Why is monetary policy said to be ineffective with fixed exchange rates and capital mobility?

Question 3. In the example above (#2), the government decides to increase spending on public works to create jobs. How does this affect internal and external balance and the exchange rate?

Why is fiscal policy said to be effective with fixed exchange rates and capital mobility?