During the 1970s, two sharp upward spikes in the world price of oil caused many countries to experience “stagflation,” that is, a simultaneous increase in inflation & unemployment. In 1979, U.S. Federal Reserve Chairman Paul Volcker decreased the U.S. money supply sharply in an effort to curb U.S. inflation.

According to the sticky-price model of KOM Ch. 15, what would be the (a) short-run & (b) long-run effects on the U.S. dollar/French franc (FF) nominal exchange rate of a one-time, permanent decrease in the U.S. money supply? Assume that the initial equilibrium is the long-run equilibrium.

At the same time as Mr. Volcker was acting to lower U.S. inflation, in France the focus was on stimulating output in order to reduce unemployment.

How would affect if there was an increase in the level of French output (output supply) at the same time as the U.S. money supply was permanently decreased? [Remember that only changes to the money supply can affect prices, which means that only changes to Ms can affect expectations about future exchange rates.]

Required

Use a graph or graphs to illustrate your answer.