Use the money market with the general monetary model, and foreign exchange (FX) market to answer the following questions. Consider 2 countries, Country A (using dollars) and B (using pounds). In Country A, the money supply, M(A), is 400 million dollars, the real income, Y(A), is 200 million, the the price level P(A), is 4 dollars, and the annual nominal interest rate, i(A), is 3 percent. In Country B, the money supply, M(B), is 100 million pounds, the real income, Y(B), is 200 million, the the price level, P(B), is 1 pound, and the annual nominal interest rate, i(B), is 3 percent. These two countries have maintained the long-run levels with the nominal exchange rate E(A/B) of 4.00. Both countries have perfect capital mobility. Note that the uncovered interest parity (UIP) holds all the time and the purchasing power parity (PPP) holds only in the long-run. Assume that the new long-run levels are achieved within 1 year from any permanent changes in the economies. Now, today at time T, the money supply of Country B falls by 3% permanently. With the fall of the money supply in Country B, the annual nominal interest rate in Country B rises by 2 percentage points, from 3% to 5% today. Unless otherwise noted, assume that the money supply in Country A, the real income in Country A, and real income in Country B, do not change at all. Treat Country A as the home country. In answering the questions use the exchange rate defined as the amount of country A's currency per 1 unit of country B's currency, E(A/B). Assume that both countries use the floating exchange rate system in answering question 8 8. Explain (in words) how this change affects the money market in Country A and the FX market in the short-run, and in the long-run. (i) For the short-run equilibrium, be sure to state the movements (shifts) of all curves (MD and MS curves in Country A, DR and FR curves) starting from the initial long-run equilibrium including the reasons for the shifts, and the movements of equilibrium levels (relative to the initial levels) for Country A's annual nominal interest rate, i(A), real money balance, M(A)/P(A), and the exchange rate, E(A/B), to get full marks. (ii) For the long-run equilibrium, be sure to state the movements (shifts) of all curves (MD and MS curves in Country A, DR and FR curves) starting from the short-run equilibrium including the reasons for the shifts, and the movements of equilibrium levels (relative to the initial levels) for Country A's annual nominal interest rate, i(A), real money balance, M(A)/P(A), and the exchange rate, E(A/B), to get full marks.

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The conversion standard is in US dollars per British pound E We need to think about how as an adjust... View the full answer