1. If one were to draw three diagrams with an IS - LM diagram on the top left, a domestic return - foreign return diagram on the right, and a money market diagram on bottom left, beginning at point A and letting the central bank(CB)tighten to fight inflation/over heating so that interest rates rise and assuming flexible exchange rates and sticky prices, what would be the the new equilibrium, after the CB tightens? Now, if they were to draw an investment demand diagram with points A and B as above, what is the intuition as to why investment changes the way it does? Using the equation for the trade balance, how is the trade balance isinfluenced by the contractionary monetary policy?
2. Assuming fixed exchange rates instead and using central bank's balance sheet, why do all of the answers from above change beginning with what happens to the real money supply?