Suppose there is a permanent decrease in the U.S. money supply. Trace the short-run and long-run effects on the current and expected exchange rate, interest rate, and price level. Draw the two-sided diagram to help explain your answer. Also, draw the time paths of each of these variables. (We assume the economy starts with all variables at their long-run levels and that output remains constant as the economy adjusts to the changes in money supply, i.e. real output Y is given.) Include in your answer a brief description of how exchange rate overshooting or undershooting may appear in this case.

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Exchange Rate ii SeS S i I MP MP MP The above diagram ... View the full answer