1. Short-run and Long-run equilibrium analysis using PPP model. The effects of a decrease in the domestic money supply. Suppose the Canadian economy was initially in a long-run equilibrium. Suppose that the Central Bank of Canada decided suddenly to implement a one-time decrease in money supply.

(a) Using equilibrium equations explain the long-run effects of a decrease in money supply on output, interest rate, price level and exchange rate. Provide the intuition for your answer.

(b) Using equilibrium equations explain how a one-time decrease in money supply today affects agentsexpectations today regarding future exchange rate? Provide the intuition for your answer.