Consider the simultaneous equilibrium in the US money market and the foreign exchange market. Assume that, in the short-run, prices are completely fixed and that they fully adjust in the long-run. Assume throughout the problem that real GNP remains unchanged.

(a) What is the effect of an increase in the nominal money supply on the interest rate in the short-run?

(b) In the long-run, prices will fully adjust - they will increase proportionally to the change in the nominal money supply. What will the interest rate be equal to in the long-run?

(c) On the graph below indicate the initial equilibrium and label it "initial". Label the corresponding exchange rate Einitial.

(d) Indicate a short-run equilibrium (after the increase in the nominal money supply but before the prices adjusted) and label it "Short-run." Label the corresponding exchange rate Eshortrun.

(e) Indicate a new long-run equilibrium point (after prices fully adjusted) and label it "Long-run." Label the corresponding exchange rate Elongrun.

(a) What is the effect of an increase in the nominal money supply on the interest rate in the short-run? (b) In the long-run, prices will fully adjust - they will increase proportionally to the change in the nominal money supply. What will the interest rate be equal to in the long-run? (c) On the graph below indicate the initial equilibrium and label it "initial". Label the corresponding exchange rate Einitial. (d) Indicate a short-run equilibrium (after the increase in the nominal money supply but before the prices adjusted) and label it "Short-run." Label the corresponding exchange rate Eshortrun- (e) Indicate a new long-run equilibrium point (after prices fully adjusted) and label it "Long-run." Label the corresponding exchange rate Elongrun. Exchange rate Dollar return After Before After Before Expected return on euro deposits Rates of return