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Australia is considered as a small open economy with a flexible exchange regime. Using IS-LM, AS-AD and interest parity (IP) graphs under the Mundell-Fleming model:

Australia is considered as a small open economy with a flexible exchange regime. Using IS-LM, AS-AD and interest parity (IP) graphs under the Mundell-Fleming model:

a) Show the impact of a reduction in price target on output, the interest rate, the nominal exchange rate, real exchange rate and price level in the short run. (10 marks)

b) Show the impact of a reduction in price target on output, the interest rate, the nominal exchange rate, real exchange rate and price level in the medium run. (12 marks)

c) Discuss the overshooting of the nominal exchange rate. (8 marks)

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