Question: Use a diagram like Figure to explain how a central bank can alter the domestic interest rate, while holding the exchange rate fixed, under imperfect

Use a diagram like Figure to explain how a central bank can alter the domestic interest rate, while holding the exchange rate fixed, under imperfect asset substitutability.

Exchange rate, E Sterilized purchase of foreign assets 2 domestic-currency return on foreign- + currency deposits,p(B-A2) R. + (Ee-E)/E + -AR) RE-EVE + p(B-A) Domestic interest rate, R LIR, Y) MS Real money supply Real domestic money holdings

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