Question 5. Asset market and money market equilibrium in the short run and long run Make the usual assumptions: UIP holds, PPP holds in the long run, prices are sticky in the short run. Suppose there is a fall in the domestic nominal money supply.

Part (a) Please illustrate the effects of this policy on the interest rate and the exchange rate in a pair of separated graphs, one for the domestic money market and one for the foreign exchange marke. Label the initial equilibrium as point A, and the new equilibrium as point B.

Part (b) Please illustrate the effects of this policy on the interest rate and the exchange rate in a pair of jointed graphs. Label the initial equilibrium as point A, and the new equilibrium as point B.