Question: Use the money market and FX diagrams to answer the following questions. This question considers the relationship between the euro (¤) and the U.S. dollar ($). The exchange rate is in U.S. dollars per euro, E$/€. Suppose that with financial innovation in the United States, real money demand in the United States decreases. On all graphs, label the initial equilibrium point A.
a. Assume this change in U.S. real money demand is temporary. Using the FX/money market diagrams, illustrate how this change affects the money and FX markets. Label your short-run equilibrium point B and your long-run equilibrium point C.
b. Assume this change in U.S. real money demand is permanent. Using a new diagram, illustrate how this change affects the money and FX markets. Label your short-run equilibrium point B and your long-run equilibrium point C.
c. Illustrate how each of the following variables changes over time in response to a permanent reduction in real money demand: nominal money supply MUS, price level PUS, real money supply MUS/ PUS, U.S. interest rate i$, and the exchange rate E$/€.