1. This question is about the IS-LM-FX model. Assume Home and Foreign are in an initial equilibrium with a floating exchange rate. Then investors become worried that, in the near future, Home will be forced to lower G in order to combat a large budget deficit.
2. Describe what will happen to Home's economy today, assuming that the central bank keeps the money supply fixed both today and in the future.
3. Now suppose that the Home central bank has the goal of stabilizing real output Y rather than the money supply. Describe the actions it will take, today and in the future, in order to fix Y and the implications for the exchange rate and interest rates.