Consider a group of open economies; assume perfect capital mobility;
(1) Assume there is a Leader country. All other countries (referred to as the Follower countries) fix their exchange rates vis-à -vis the Leader country. Discuss the effectiveness of monetary policy in the Follower countries.
(2) If the Leader country reduces its money supply to fight inflation, what must the Follower countries do to maintain their fixed exchange rate? What is the effect on their economy? What would happen in the Follower countries if they did not change their money supply?