You have been appointed policy advisor of the country Economia. The
country is an open economy, has a floating exchange rate regime and
uses the Econ as its currency.
To answer the following questions, provide an explanation (discussion in
words). Support your answer with equations and graphs where this is
helpful.
1. (20 marks) The government is trying to understand the effect of
the following shocks on the exchange rate (/), the home and
foreign price level and real money balances. Use the fundamental
equation of the monetary approach to advise the government on
the effect of each of these shocks.
a. A decrease in home money supply (5 marks)
b. An increase in foreign real income (5 marks)
c. An increase in the home nominal interest rate (5 marks)
d. An increase in the foreign nominal interest rate (5 marks)