Assume that prices are sticky in the short run. Use the MM-FX model to demonstrate the effects of each event below. After explaining your reasoning, answer clearly whether there is exchange rate overshooting in each case. In addition, display the time paths of the dollar interest rate, the euro interest rate, and the dollar-euro exchange rate.
Assume that prices are sticky in the short run. Use the MM-FX model to demonstrate the effects of each event below. After explaining your reasoning, answer clearly whether there is exchange rate overshooting in each case. In addition, display the time paths of the dollar interest rate, the euro interest rate, and the dollar-euro exchange rate.
a) The US central bank decreases money supply by 5% and reverses the policy in three months.
b. The US central bank decreases money supply by 5% and reverses the policy in three months. At the same time, US output declined by 2% over the same three-month period. Assume that the elasticity of money demand with respect to output is 1.
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