Suppose the current dollar-peso spot exchange rate equals $0.08/Ps, but it fluctuates with the forces of supply and demand. Due to domestic turmoil, assume that Mexican peso holders suddenly demand the U.S. dollar.
a. Draw the supply and demand curves in the Mexican peso real loan able funds market. Make sure you correctly label both axes. Show the effect that capital flight from Mexico should have, if any, on the peso real risk-free interest rate. Provide a reason for why supply and/or demand will change. If there are no changes in either supply or demand, explain why.
b. To provide jobs for the poor, suppose that Mexico's president increases government spending. Explain what effect, if any, this spending should have on Mexico's monetary base.
c. Draw the supply and demand curves for the dollar-peso foreign exchange market. Make sure you correctly label both axes. Show the effect capital flight from Mexico should have, if any, on the value of the peso.
d. Is it correct to say that, if the Mexican central bank does not intervene in the foreign exchange market, capital flight will cause the nation's CT to go into surplus?