Sweden is a small open economy that adopts a flexible exchange rate

Question 1 (30 points)
Sweden is a small open economy that adopts a flexible exchange rate, and the market perceives
the American assets as the only safe assets. Suppose the Swedish economy is characterized by the
DD-AA model; and, for simplicity, assume that the Swedish economy is initially operating at its
full capacity.
a) Recently, the Swedish government announced it has lifted all COVID restrictions. This
announcement has boost confidence in the economy; as a result, spending on dinning out and
equipment purchase increases permanently. In the context of the DD-AA model. What
happens to the Swedish current account and balance of payments in both short run and long
run? Explain with the aid of ONE DD-AA diagram. (20 points)
b) Now, suppose the central bank of Sweden, Sveriges Riksbank, finds the change in the kr/US$
exchange rate in part (a) undesirable and wants to keep it at the initial level. At the same time,
the Sveriges Riksbank wants to keep the amount of money circulated in the economy from
changing. Do you think it achieve these goals? If yes, explain what they should do and discuss
how the chosen policy affects the country’s balance of payment account. If no, explain the
rationale behind. Make sure to support your answer with the diagram from part (a). DO NOT
draw a new one; otherwise, you will not receive credits. (10 points)
Note: Exchange rate is quoted as Ekr/US$, where kr = Swedish krona. DO NOT use DC/FC in your
explanation; otherwise, you will receive a grade of ZERO for the whole question.
Question 2 (20 points)
“The DD-AA model predicts there will be no change in current account when new payment
technology is introduced to the country such that households no longer use cash as the primary
method of making payments permanently.” True/False/Uncertain, explain with the aid of ONE
DD-AA diagram.