Discuss, with the help of Krugman-Obstfeld-Melitz' AA- and DD-curves, the effects of a contractive fiscal policy (a decrease in government spending) on the interest rate, the nominal and real exchange rates, output and the price level!
a) What are the effects of a temporary decrease in government spending?
b) What are the effects of a permanent decrease in government spending? Distinguish between the short run (fixed price level, variable output) and the long run (variable price level, output at its equilibrium level).