5. Suppose that the Democratic Republic of Congo can be described as the following classical economy:

AD Y = 5000 + 50 M/P AS Y = Y = 15,000 million CF, Congolese franc Assume that Congo produces only precious metals and trades them for machinery from China. The real exchange rate,

e, equals 5 units of precious metal for 1 units of machinery. The foreign price level is CNY 1 million (Chinese renminbi) per unit of machinery, and Congo’s domestic money supply is CF 4000!million.

a. What is the domestic price level? What is the fundamental value of the nominal exchange rate?

b. Suppose that Congo fixes its exchange rate at 1/50 CNY per CF. Is its currency overvalued, undervalued, or neither? What will happen to Congo’s central bank’s stock of official reserve assets if it maintains the exchange rate at 1/50 CNY per CF?

c. Suppose that Congo wants a money supply level that equalizes the fundamental value of the exchange rate and the fixed rate of 1/50 CNY per CF.

What level of the domestic money supply achieves this goal? (Hint: For the given real exchange rate and foreign price level, what domestic price level is consistent with the official rate? What domestic money supply level will yield this price level?)