In our discussion of short-run exchange rate overshooting, we assumed real output was given. Assume instead that an increase in the money supply raises real output in the short run (an assumption that will be justified in Chapter 6). How does this affect the extent to which the exchange rate overshoots when the money supply first increases? Is it likely that the exchange rate undershoots? (Hint: In Figure, allow the aggregate real money demand schedule to shift in response to the increase in output.)

Short-Run and Long-Run Effects of an Increase in the U.S. Money Supply (Given Real Output, Y)

(a) Short-run adjustment of the asset markets.

 (b) How the interest rate, price level, and exchange rat move over time as the economy approaches its long-run equilibrium.

 

Transcribed Image Text:

Dollarlouro exchange to Ea MS U.S. real monay holdings M ↓ Dollar natum Expectad auto ratum L(P__Y) ↓ (a) Short-run effects Eyc Fatos of ratum n 0 dollars) Dollar ratum Expactad auto naturn L(P₂Y) U.S. real money supply U.S. real money holdings (b) Adjustment to long-run equilibrium Dollarlouro exchange to Ea MS U.S. real monay holdings M ↓ Dollar natum Expectad auto ratum L(P__Y) ↓ (a) Short-run effects Eyc Fatos of ratum n 0 dollars) Dollar ratum Expactad auto naturn L(P₂Y) U.S. real money supply U.S. real money holdings (b) Adjustment to long-run equilibrium

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In our discussion of shortrun exchange rate overshooting we assumed real output was given Assume instead that an increase in the money supply raises r... View the full answer