Consider the following Keynesian small open economy:
Cd = 200 + 0.69 Y.
Id = 80 - l000r.
G = 20.
NX = 85 - 0.09Y - e.
e = 90.
M = 115.
L = 0.5Y - 200r.
= 300.
In this economy, the real interest rate does not deviate from the foreign interest rate.
a. Assuming this economy is in general equilibrium, what is the value of the interest rate r?
b. Assuming fixed nominal exchange rates and a fixed domestic price level, what is the effect on domestic output if the foreign interest rate increases by 0.05? What is the size of the nominal money supply in the new short-run equilibrium?
c. Assuming flexible exchange rates and a fixed domestic price level, what is the effect on domestic output if the foreign interest rate increases by 0.05? What is the value of the real exchange rate in the new short-run equilibrium?
d. In the long run, how does the domestic price level respond to an increase in the foreign interest rate?