Standard's downgraded a country's credit ratings indicating a greater risk to investors. Investors should therefore now demand a higher risk premium.

Assume the country has a flexible exchange rate. Use the Mundell-Fleming model to show and explain, by referring to the events in the goods market and the financial market (i.e. the money market and the exchange rate market), the short-run predicted effect of the country's risk premium on output, employment, trade balance and the exchange rate.

In the case where the country has a fixed exchange rate, explain how the IS-LM market will change.