* Question 3: Leaning against the wind [Based on Turnovsky (1979)] Consider the following model of a small open economy featuring perfect capital mobility and sluggish price adjustment: y=-9R +8(e+p* -p), n>0, 00, (Q4.6) P = (y-4), >0, (Q4.7) R=R* +, (Q4.8) where y is actual output, R is the domestic interest rate, e is the nominal exchange rate, p* is the exogenous foreign price level, p is the domestic price level, m is the nominal money supply, y is (exogenous) full employment output, and R* is the exo- genous world interest rate. All variables, except the two interest rates, are measured in logarithms. As usual, a dot above a variables denotes that variable's time rate of change, i.e. p = dp/dt and = de/dt. Assume that the policy maker adopts the following policy rule for the nominal money supply: m = -4(e - ), u 20, (Q4.9) where m is the exogenous component of money supply, is the equilibrium exchange rate, and u is a policy parameter. (d) Under what condition(s) is the model saddle-point stable? Which is the jump- ing variable and which is the predetermined variable? (e) Illustrate the phase diagram of the model for the case where the policy maker engages strongly in 'leaning against the wind' (so that nue > As). (f) Assume that yu = 18. Derive the impact, transitional, and long-term) effects of an unanticipated and permanent increase in the foreign price level, p*. Why is there no transitional dynamics in this case