Demonstrate the idea of fx "overshooting" specifically using the case where the central bank loosens monetary policy. Use the chart below.

First, in the short run, discuss what happens in the money market.

Second, in the short run, discuss what happens in the FX market.

Third, in the short run, discuss what happens to the expected return on foreign-currency assets.

Fourth, in the long run, what happens to prices.

Fifth, in the long run, what happens in the money market.

Domestic currency (DC) return Expected foreign currency (FC) retum Rate of return (DC tens) LEY M P Real money supply Real MIP