 macroeconomic policy in an open economy with flexible exchange rate. So, in this way macroeconomic policies work in open economies. Today, we will study the case that when exchange rate is flexible or determined by the market forces demand and supply. So, there are two basic questions. The first is how do fiscal and monetary policy affect a country's real exchange rate and net exports, that any change occurs in fiscal or monetary policy. So, what is the impact of the exchange rate and net exports of the country? The first question is that how do the macroeconomic policies of one country affect the economies of other countries? For example, if a policy changes in Pakistan, then the net exports of Pakistan and the exchange rate of Pakistan will have an impact. And the second is that the trading partners of Pakistan will have an impact on those countries. So, the three steps involved in answering these questions are the first, use the domestic economies ISLM diagram to see the effect on domestic output and the domestic real interest rate. In the first step, we will study through the ISLM framework that when a policy changes, then due to that change, the domestic country, that is, the policy of Pakistan is changing. So, the output of Pakistan and the real interest rate of Pakistan will have an impact on that. The second step is to see how changes in domestic real interest rate and output affect the exchange rate and net exports. Because of this policy, the change in the output and the interest rate will have an impact on the net exports and the real exchange rate. In the second step, we will study and then in the third step, we will study the foreign economies ISLM, we will take the structure, ISLM diagram to understand that our trading partners, foreign countries, because of this change, the net exports and the real exchange rate of Pakistan will have an impact on those economies, on their output and on their interest rate. So, today we will study the fiscal policy in this module. So, examine the effects of a temporary increase in the domestic government purchases using the classical RBC model. So, the rise in government purchases shifts the IS curve up. In Pakistan, for example, government purchases, government spending will have an impact on the IS curve, it will shift up and to the right. Because we know that the IS curve represents the goods market and the government spending is an important component of the total goods market demand. And similarly, FELine will shift to the right. Why FELine will shift? In the RBC model, we saw that when the government increases its spending, then what will happen as a result of that? Will the government finance it? Or will it immediately add taxes? And if it does not add taxes at the same time, then it will borrow from somewhere, but it is in the future. To repay that amount, it will have to pay taxes. So, in the future, it will have to pay taxes. And when you pay taxes, then you know that consumers feel poorer because of higher taxes and then they will increase their labor supply in the labor market because of which FELine will shift to the right. So, with the help of this diagram, we can understand that initially you had this FELine. Okay? IS1 was the initial curve. And similarly, it was the LM curve. So, these three curves are intersecting on point E. So, from here, your output is becoming more interested. So, an increase in government spending, IS curve will shift from IS1 to IS2. It will shift to upward. And FELine will also shift to the right. So, now the new equilibrium point IS and FELine are intersecting at point F. And when it is on F, then the prices have increased in demand. So, because the prices have increased, the LM curve will shift to the left and the LM curve will also come to F point and intersect. So, what will be the outcome of this? That the domestic output will increase. Okay? It is showing the arrow. The real interest rate has increased. When you are going on F from E, the interest rate has increased. There will be less in net exports. What are net exports? Exports minus imports. Okay? So, when your income has increased, then the imports will increase. And these imports will become less in net exports. And the domestic prices will increase because this will shift to LM curve and the domestic prices will increase. What will happen in this? LM curve will shift up and to the left to restore equilibrium as the price level. Both the real interest rate and output will rise in domestic economy. Okay? The equilibrium point will be at higher output and at higher interest rate. So, higher output reduces the exchange rate. When your output level increases, then your imports will increase and because of the increase in imports, the exchange rate will depreciate. Because you are directly importing, you are supplying your country more and demand more foreign currency. So, your exchange rate will reduce. But with this, this is the impact of the increase in output. And when the interest rate increases, then the impact of this will be reversed. Okay? Higher real interest rate will increase the exchange rate. When your country's interest rate is high, then it will attract other countries that the capital and the currency demand will increase and the exchange rate will increase. So, the effect on the exchange rate is because of the increase in output, because of the depreciation and the real interest rate. So, what will be the net outcome? So, theoretically we cannot determine this. So, the net outcome is ambiguous. Higher output and higher real interest rate both reduce net exports. The impact on the exchange rate is ambiguous, but the impact on the net exports is clear that due to the increase in output, the net exports will decrease. Imports are due to increase and due to the increase in interest rate, the net exports will decrease. Sporting the twin deficit hypothesis. So, if you recall, we talked about the twin deficit. The fiscal deficit and the account deficit, we sometimes recall it as the twin deficit. So, when your fiscal deficit is increased, then the current account deficit will also increase. So, now we will see how these changes will affect the foreign countries' economy. Our trading partner has a change in our country's fiscal policy. The decline in net exports for the domestic economy means a rise in net exports for the foreign country. So, the foreign countries' IS curve shift up and to the right. In the classical model, the LM curve shifts up and to the left as the price level rises to restore equilibrium, thus raising the foreign real interest rate, but the foreign output is unchanged. In the Keynesian model, the shift of the IS curve would give the foreign country higher output temporarily. We understand these things with the help of the diagram that the trading partner of the foreign country has an impact on that. We are studying with the help of this IS-LM model. This was your original equilibrium point, on which the IS-FE line and LM curve were intersecting. Due to the change in our fiscal policy, which was less in our net exports, our trading partner's next exports increased and the IS curve shifted up and to the left. So, in the Keynesian model, the short-term equilibrium will be at each point in which your foreign country's output will increase. But what will happen in the long-term? Because of the increase in the price, the LM curve will shift up and the equilibrium will shift to F point. So, what is the situation at F point? There is no change in the foreign country's output, but there is an increase in the interest rate. So, foreign income is unchanged. In the classical model, in the short-term, in the Keynesian model, there is an increase. In the real interest rate, there is an increase in foreign prices. So, in either the classical or Keynesian model, a temporary increase in the domestic government purchases raises domestic income. In the country where the policy is changed, there is an increase in the income and domestic real interest rate increases as in the closing economy. It also reduces domestic net exports. So, government spending is crowd out both investment and net exports. How is the increase in government spending crowd out? There is a decrease in investment and there is a decrease in net exports. The effect on the exchange rate is ambiguous. We discussed that it moves in the opposite direction and its net effect is ambiguous. The foreign real interest rate and price level rise, which is your trading partner, the foreign economy, the interest rate and price level will increase in the Keynesian model, the foreign output will rise temporarily. So, today we have seen how the impact of the change of the fiscal policy is in the open economy. When the exchange rate is flexible, then how does it affect domestically and its trading partners? Thank you.