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5) COMBINED APPROACH: Show what happens in the home money market and the FX market for the exchange rate Eh/f in both the short run
5) COMBINED APPROACH: Show what happens in the home money market and the FX market for the exchange rate Eh/f in both the short run and the long run when there is a permanent decrease in the home money supply at some time T. (Once again, the home country is denoted h and the foreign country denoted f). You should put your money market diagrams on the left and your FX market diagrams lined up with them on the right. You should put your short run diagrams above your long run diagrams. (These conventions make them easier to grade.) Label all axes, curves, interest rates, exchange rates, and money supplies (noting both the M and P parts of the money supply), and draw arrows showing which curves shift, being careful to make a distinction between short run shifts and permanent shifts, and shifts that return to their starting place. Then, draw time series graphs of the variables nominal money M, prices P, real money M/P, the home interest rate i, and the exchange rate Eh/f, being sure to label all axes and time T on each horizontal axis. You may choose to draw the M/P and i graphs on the same axes the way the book does. (Your complete answer is four graphs of markets and four or five time series graphs and may require two pages.) [22 pts. = 12 pts. for market graphs + 10 for time series graphs]
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