The Mundell-Fleming model takes the world interest rate r as an exogenous variable. Let's consider what happens when this variable changes.

i. What might cause the world interest rate to rise? (Hint: The world is a closed economy.)

ii. If the economy has a floating exchange rate, what happens to aggregate income, the exchange rate, and the trade balance when the world interest rate rises?

iii. If the economy has a fixed exchange rate, what happens to aggregate income, the exchange rate, and the trade balance when the world interest rate rises?

d. In the Mundell-Fleming model with floating exchange rates, explain what happens to aggregate income, the exchange rate, and the trade balance when taxes are raised. What would happen if exchange rates were fixed rather than floating?