You may assume that there are open capital markets, and that prices are sticky in the short run but perfectly flexible in the long run. For full marks, be sure to label any diagrams clearly and completely.

1. Consider a world with two countries, home and foreign. The economy is initially in an equilibrium. What combination of policies (fiscal, monetary) could the government use to improve the trade balance without changing the level of output? Show the effects of these policies by using an AA-DD-XX diagram.