3 (65 marks) (Open Economy IS-LM and Dornbusch Model): Consider the following open-economy IS-LM model, where capital is perfectly mobile across countries. Assumptions: i) the domestic and foreign price Pt and P t are constant at period t. 2. UIP condition: it = it Et(st 1) st holds, where st 1 = ln(St 1) and st = ln(St), and St is an exchange rate between a Home currency and foreign currency. 3. Standard IS-LM setting, where IS curve is given by Yt = Ct(Yt Tt) Gt It NXt(Yt, Y t , St). d) (20 marks) Initially, it = 3%,it = 3%, St = EtSt 1 = S , and the money supply was reduced permanently by 1%. Moreover, this money supply decrease leads to an increase in it by 1%. The relative PPP holds in this economy in the long-run. Plot the nominal exchange rate moments upon a government's monetary policy, and explain i) how St changes in the short and long-run. ii) how Pt changes over time