Zambia a small open economy with flexible exchange rate and free capital mobility is experiencing macroeconomic instability. This is due to the recent slump in global growth resulting in low commodity prices on the international market which has led to a sharp depreciation in the domestic currency, the Zambian kwacha. To help restore confidence in the Zambian Kwacha the Minister of finance in his budget speech announced the start of fiscal consolidation while the Bank of Zambia governor announced a tight monetary policy stance. Use the IS-LM-BOP models to explain the effect of these actions on the exchange rate, net exports, economic activity, investment, interest rate Page 5 of 5 and consumption. Please explain the economic intuition behind the changes. (10 Marks) b) Now assume that due to the continued depreciation of the Zambian kwacha as well as the criticisms from the civil society and the opposition, the Minister of Finance has decided to peg the Kwacha to the US-dollar. Explain the effect of contractionary fiscal and monetary policies on the exchange rate, net exports, economic activity, investment, interest rate and consumption. Please explain the economic intuition behind the changes. (10 Marks) c) Describe the "impossible trinity hypothesis". (5 Marks) [TOTAL: 25 MARKS]