4. How would a decrease in the money supply of Paraguay (currency unit: the guaran) affect its...

4. How would a decrease in the money supply of Paraguay (currency unit: the guaraní) affect its own output and its exchange rate with Brazil (currency unit: the real). Do you think this policy in Paraguay might also affect output across the border in Brazil? Explain.

5. For each of the following situations, use the IS–LM–FX model to illustrate the effects of the shock and the policy response. For each case, state the effect of the shock on the following variables (increase, decrease, no change, or ambiguous):

Y, i, E, C, I, and TB. Note: in this question (unlike in the Work It Out question)

assume that the government allows the exchange rate to float but also responds by using monetary policy to stabilize output.

a. Foreign output increases.

b. Investors expect an appreciation of the home currency in the future.

c. The home money supply decreases.

d. Government spending at home decreases.

Hint: In each case, make use of the goods market equilibrium condition to understand what happens to consumption, investment, and the trade balance in the shift from the old to the new equilibrium.