INTERNATIONAL FINANCE/ MACROECONOMICS You have been appointed policy advisor of the country Economia. The country is an

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INTERNATIONAL FINANCE/ MACROECONOMICS 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.
3. (30 marks) Strong economic activity in Economia causes an
increase in money demand.
a. Use the money market and FX market diagrams to illustrate the
short-run and the long-run effects of the increase in money demand,
assuming that it is temporary and lasts between time T and T+5. (7
marks)
b. Use the money market and FX market diagrams to illustrate the
short-run and the long-run effects of the increase in money demand,
assuming that it is permanent. (7 marks)
c. With time on the horizontal axis, show how a temporary and a
permanent increase in money demand affect the nominal interest
rate, real money balances, the price level and the exchange
rate (𝐸𝐸𝑐𝑜𝑛/𝐹). (7 marks)
d. Does a permanent increase in money demand lead to exchange
rate overshooting? What if the shock is temporary? Explain. (9
marks)