Assume that Janet Yellen (chair of the US Fed Reserve) decides to reduce the US money supply (i.e., contractionary monetary policy).
1) Using the concept of money market equilibrium, explain what will happen to interest rates and prices in the U.S. in the short-run.
2) Using the concept of interest-rate parity explain what will happen to the exchange rate of the dollar in the short-run (i.e., will it appreciate or depreciate?).
3) Given your answers to (1) and (2), do you think this policy is designed to stimulate the economy (i.e., increase production in the U.S. in the short-run)? Explain.
4) Using the concept of money market equilibrium, explain what will happen to interest rates and prices in the U.S. in the long-run.
5) Using the concept of purchasing-power parity explain what will happen to the exchange rate of the dollar in the long-run (i.e., will it appreciate or depreciate?).
6) Given your answers to (4) and (5), do you think this policy is designed to stimulate the economy (i.e., increase production in the U.S. in the long-run)? Explain.