During the 1990s, American depositors dramatically increased the share of their funds in money market mutual fund accounts. Although these accounts have restrictions (such as limited access to funds and minimum deposit requirements), they offer depositors higher interest rates than does standard checking. The widespread use of financial instruments during the 1990s led to a decrease in money demand because people held a smaller share of their deposits in checkable accounts (demand deposits).

a. How would this shock affect the U.S. output, interest rate, exchange rate, consumption, investment, and trade balance?

b. How would your answer to (a) change if the Fed used monetary policy to stabilize output?

c. How would your answer to (a) change if the Fed used monetary policy to maintain a fixed exchange rate?