Suppose that you are the chief economic adviser in a small open economy with a floating-exchange-rate system. Your boss, the president of the country, wishes to increase the level of output in the short run-in order to win re-election.

a.

Do you recommend using expansionary or contractionary monetary or fiscal policy? Use the Mundell-Fleming model to illustrate graphically and explain your proposed policy. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short run equilibrium.

b.

If the policy you recommended above was used in a small open economy with fixed exchange rate, what are the outcomes? Use the Mundell- Fleming model to illustrate graphically your answers.