The Mundell-Fleming model takes the world interest rate r as an exogenous variable. Leti´s consider what happens when this variable changes.
(a) What might cause the world interest rate to rise?
(b) In the Mundell-Fleming model with a a´oating exchange rate, what happens to aggregate income, the exchange rate, and the trade balance in a small open economy when the world interest rate rises?
(c) In the Mundell-Fleming model with a O¨xed exchange rate, what happens to aggregate income, the exchange rate, and the trade balance in a small open economy when the world interest rate rises?