A flexible exchange rate combined with a willingness to change the domestic interest rate can increase the effectiveness of monetary policy in an open economy. Consider an economy that suffers a fall in business confidence? (which tends to reduce? investment). Let UIP stand for the uncovered interest parity condition.Suppose the economy has a flexible exchange rate. In an ?IS-LM-UIP? diagram, which is the new? short-run equilibrium if there is a fall in business confidence and the central bank leaves the interest rate? unchanged? Assume the economy was at point A.??

The new? short-run equilibrium of the economy when business confidence falls is point? ?

+ + S UIP F C F Domestic interest rate, i Domestic interest rate, i LM A, D . D A . B . E B Output. Y Exchange rate. E