A. In this question, we will analyze in stages the effects of competition for monetary gold under a gold standard. For purposes of this problem, imagine monetary policy in traditional terms as choosing the money supply. Start with the case of an SDE with a fixed exchange rate. Imagine there is a gold standard so that FOREX is gold. Suppose the central bank attempts a traditional monetary contraction. Show the effect in an IS-LM-UIP diagram. What happens to the amount of monetary gold (FOREXJ held by the central bank? Now suppose there is second country [it could be the rest of the world). Call it Foreign. Given the results in part (a) what must happen to the monetary gold (FOREX) in the central bank of Foreign? Therefore, what happens to the money supply in Foreign? What would tend to happen to the LM curve and the interest rate in Foreign? In order for exchange rates to be fixed in both countries, what must be the relationship between interest rates in Home and Foreign? Now relaxing the assumption that Home is a small country, what must happen to the money supply and the LM curve in both countries? What happens to output in both countries? Suppose that Foreign is concerned about the effect on its monetary gold. What action could it take to offset the effect on its monetary gold that you discovered in part [b]? How would this effect output in the Home and Foreign countries? One might object that Foreign could undertake a monetary policy to offset the effect on output it experienced in part (b). What monetary policy would this be? Would it change the qualitative effect on Foreign's monetary gold? Would it change the effect on Home output? Given the results in part (el, Home might be tempted to continue to engage in the policy in part [a]. What effect would this have on the monetary gold of Foreign? What kind of monetary policy would Foreign have to use to prevent this effect? Explain how this returns the world economy to the situation in part (d)