For each of the following scenarios, assume that the economy experiences an exogenous decrease in investment demand. For each case, illustrate the IS‒LM‒FX diagram and state the effect of the shock (increase, decrease, no change, or ambiguous) on the following variables: Y, i, E, C, I, TB. Here, we assume that the policymakers’ objective is to keep output fixed at its initial value.

a. Monetary policy response under a floating exchange rate regime

b. Fiscal policy response under a floating exchange rate regime

c. Monetary policy response under a fixed exchange rate regime

d. Fiscal policy response under a fixed exchange rate regime

e. Suppose that investors expect the central bank to respond to the shock and that the economy has a floating exchange rate regime. How would this affect their expectations about the exchange rate following the shock? How will they respond? In other words, how will they shift their portfolio between home versus foreign deposits? Explain briefly.

f. Repeat (e), assuming a floating exchange rate regime and that investors expect a fiscal policy response.