III. Short-run Adjustment: Flexible Exchange Rates 5. (16 points) Consider a small open economy with a flexible exchange rate and output initially equal to Yn. Assume that the central bank sets the nominal interest rate. Suppose there is a temporary decline in consumer confidence. a. Show the short-run effect of the decline in consumer confidence in an IS-LM-UIP diagram. What happens to output? b. Now suppose that the central bank wants to return the economy to Y=Yn. What should the central bank do? In a new diagram, show the combined (short-run) effects of the decline in consumer confidence and the central bank policy. What happens to the exchange rate, NX, and investment as a result of the change in consumer confidence combined with the central bank's policy? III. Short-run Adjustment: Flexible Exchange Rates 5. (16 points) Consider a small open economy with a flexible exchange rate and output initially equal to Yn. Assume that the central bank sets the nominal interest rate. Suppose there is a temporary decline in consumer confidence. a. Show the short-run effect of the decline in consumer confidence in an IS-LM-UIP diagram. What happens to output? b. Now suppose that the central bank wants to return the economy to Y=Yn. What should the central bank do? In a new diagram, show the combined (short-run) effects of the decline in consumer confidence and the central bank policy. What happens to the exchange rate, NX, and investment as a result of the change in consumer confidence combined with the central bank's policy