Q1Consider a small-open endowment economy described in Topic 4 with free capital mobility, a single traded good per period, and a government that levies lump-sum taxes to finance government purchases

Q1Consider a small-open endowment economy described in Topic 4 with free capital mobility, a single traded good per period, and a government that levies lump-sum taxes to finance government purchases. Assume that there is no physical capital and hence no investment. Assume that the economy exists for an infinite number of periods. Assume a floating exchange rate where the central bank expands the quantity of money at a constant rate. Assume that the government has reached its borrowing limit and thus cannot finance the fiscal deficits by issuing additional debt. Explain in THREE sentences what tradeoff the government faces when choosing the rate of monetary expansion to finance its deficit.

Q2Consider a two-period small open economy with two sectors: tradable and nontradable goods. The representative household lives for 2 periods and receives endowments of both goods. Assume that household’s consumption is a composite of tradable and non-tradable goods described by Cobb-Douglas aggregation technologies as in Topic 3. Explain in THREE sentences how a decrease in the world interest rate would affect the real exchange rate.