(a) Suppose the Fed decides to increase the money supply. Based on your understanding of the market for foreign exchange, graphically illustrate and explain what effect this expansionary monetary policy will have on the market for foreign exchange and on the exchange rate (E).
For this question, let it represent the interest rate on the U.S. one-year discount bond, i ∗ t represent the interest rate on the British one-year discount bond, and E represent the dollar price of the British pound. Assume that policy makers are pursuing a flexible exchange rate regime, and that P is fixed (therefore, ignore any AS/AD analysis.)
(a) Suppose the Fed decides to increase the money supply. Based on your understanding of the market for foreign exchange, graphically illustrate and explain what effect this expansionary
(b) Now, suppose there are two countries identical in every way with the following exception: country A is closed in terms of both the goods and financial markets while country B is open with a flexible exchange rate regime. Further suppose that the central banks in both countries increase the money supply by the same amount. Briefly explain the extent to which, if any, the output effects of these identical monetary expansions will differ in the two countries.
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