Suppose currently that the Central Bank of Econistan follows money supply targeting policy and announces monetary policy in advance to avoid sending mixed signals to the public. While the Central Bank continues to pursue the policy of money supply targeting, with the onset of the COVID-19 pandemic, citizens of Econistan suddenly start avoiding the use of banknotes and coins in their transactions, and they start using more of no-contact credit cards. This change in behavior of the agents occurred so fast that the Central Bank had no time to process and understand what was happening.

a)(15 p) Within the context of the Friedman-Lucas money surprise model, examine the impact of this surprise change in the demand for money. First of all, what is the direction of the change in demand for money, secondly, show the effects on appropriate diagrams and discuss the effects on aggregate output, employment, real interest rate, price level, real wage. Do you think the final equilibrium outcome is efficient, relative to what would occur if everyone in this economy had perfect information, including the Central Bank? Why or why not?

b)(10 p) If you find the final equilibrium outcome inefficient compared to the outcome if everyone had full information, what would be your suggestion to the Central Bank of Econistan in terms of monetary policy in order to avoid inefficiencies in the economy? How would this proposed policy work? Explain using diagrams and discuss.