Asset market equilibrium in the short run.
- (a) Using asset market equilibrium conditions explain how changes in output, Y , affect exchange rate (i.e., how an increase/decrease in output affect the exchange rate). Draw the relationship between output and exchange rate on a figure (i.e., draw the AA schedule).
- (b) Show graphically how AA schedule is affected by:
i. an increase in expected exchange rate, E^e
ii. an increase in domestic money supply, M^s
In each of these cases provide the intuition behind the change in AA schedule