Consider a world with some capital mobility; the home country's capital account improves as domestic interest rates rise relative to the world rate of interest. Initially, the home country is in internal and external balance. (Draw the IS , LM , and BB schedules.) Assume now that the rate of interest abroad increases.
a. Show the effect of the foreign interest rate increase on the BB schedule.
b. What policy response would immediately restore internal and external balance?
c. If the authorities took no action, what would be the adjustment process along the lines described by the monetary approach to the balance of payments?