4. Permanent Versus Temporary Policies

This question considers how the foreign exchange (FX) market will respond to changes in monetary policy. For these questions, the home country is Britain, and foreign is the Eurozone. The home exchange rate is British pounds () per euro E/. Use the combined (side-by-side) home money market and FX diagrams to answer the following questions. Clearly label the figures: axes, equilibrium points, levels of variables. Explain briefly.

a. Suppose the Bank of England temporarily increases its money supply. Illustrate the short run (label equilibrium point B) and long-run effects (label equilibrium point C) of this policy.

b. Suppose the Bank of England permanently increases its money supply. Illustrate the short run (label equilibrium point B) and long-run effects (label equilibrium point C) of this policy.