Assume that the Federal Reserve (the central bank of the US) is manipulating the interest rate by adjusting the amount of money supply and the policy change is permanent.

Assume that the real output level (Y) rises in response to the increase of the money supply so that the real money demand increases slightly in response to the increase of money supply. In addition, assume that the equilibrium interest rate declines in response to the increase of money supply.

How does the assumption of the real money demand written above affect the extent to which the exchange rate overshoots when the money supply increases?

Select one:

a. The extent to which the exchange rate overshoots will be larger under the assumption of the real money demand written above.

b. The extent to which the exchange rate overshoots will be smaller under the assumption of the real money demand written above.