Since 1992, the United Kingdom has operated under floating exchange rate policy, i.e. the Pound Sterling is freely floating although the government has tried, and succeeded, in maintaining an inflation rate broadly in line with Europe. Following the vote to leave the European Union, the Bank of England, reduced its interest rates and the government announced an increase in expenditure.

a.Using appropriate models and diagrams to illustrate, compare the relative effectiveness of expansionary fiscal and monetary policy as means of supporting aggregate demand under a system of floating exchange rates.

b.Explain and discuss the key determinant of exchange rate in a free market.