Bulgaria has a fixed exchange rate, and the Bulgarian currency, the lev, is pegged to the euro. Bulgaria is currently in its long-run equilibrium. Besides, market participants perceive Bulgarian assets to be riskier than assets in the member states of the European Union.
Each part of the question is NOT related to other parts of the question. Also, for each part of the question supports your answer with ONE DD-AA diagram.
a) Suppose the Bulgarian National Bank (BNB), the central bank of Bulgaria, wants to keep money supply constant, what should it do in the short run when there is an increase in business investment? What happens to the short-run level of output and the nominal interest rate in Bulgaria? (15 points)
b) Due to geopolitical tensions in the region, money holders in Bulgaria and the EU member states hold a larger fraction of the income in the form of money. What happens to the employment level and the stock of official reserves in Bulgaria in the short run? (15 points)
Note: Quote the exchange rate as Elev/euro. Use the subscripts "B" and "EU" to represent all the terms used for Bulgaria and the European Union respectively in your written explanation. You must use these notations; otherwise, you will receive a grade of ZERO for the whole question.