We discussed numerous times the importance of identifying shocks to money demand.In particular, we argued that the policy implications of shocks to money demand differ based on whether the shock to money demand was real or portfolio.

a) (5 points) Let us consider a portfolio shock that increases money demand, say due to non-monetary assets becoming riskier and less liquid.Draw a real money demand and real money supply diagram locating the initial equilibrium point as point A and then locate the new equilibrium, assuming the Fed did nothing as point B.Employing our general equilibrium framework, what would happen to output in the short run and why?