Suppose prices are sticky in the short term. Yielding to foreign pressure, China reduces its domestic money supplypermanently.

a. (5 Points) Use a joint diagram showing the nominal exchange rate, expected currency returns, and real money holdings to analyze the short-term effects on the Chinese interest rate, the Chinese price level, and the nominal exchange rate relative to the USD.

b. (5 Points) Now, assume that prices are fully flexible. How do short- term and long-term responses differ?