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). c) (20 marks) The central bank conducts a contractionary monetary policy through reducing the money supply, and EtSt+1 is fixed at S even after the monetary policy. i) Show how the domestic interest rate it changes responding to the monetary policy in a IS-LM graph. ii) How the exchange rate St changes? iii) Do we have "under" or "over" shooting of exchange rate dynamics? iv) What would be the effect of the policy on the net exports