Consider a country that operates under a managed float exchange rate system and investors perceive domestic assets and foreign assets as imperfect substitutes. Suppose the domestic central bank undertakes a sterilized foreign exchange intervention by selling foreign currency (assume it is a temporary change).

a) What impact will this policy have on the spot exchange rate in the short run, assuming real output and price level remains unchanged? Use word and a diagram that displays the domestic money market and the foreign exchange market to support your argument and assume the change in temporary.

b) Now, let's take the changes in output into consideration. Use the DD-AA model to show and explain the effects of this sterilized foreign exchange intervention on the short-run level of output and exchange rate.