Explain the exchange rate overshooting with a permanent decrease in the country's money supply by using...

Explain the exchange rate overshooting with a permanent decrease in the country's money supply by using the graphs

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Expert Solution

In terms of currency supply adjustment, excessive nominal exchange rate fluctuations. The market stickiness is seen in the short term, which is why the exchange rate swings rapidly from day to day. Now that price adjustments do not immediately affect actual balances and a nominal interest rate. Monetary surprise.

Let's think of a reduction in the supply of money. The discovered interest balance notes that the positive difference between national and international nominal interest rates would be offset by a nominal appreciation. The exchange rate however automatically changes to suit the supply of ForEx to the demand of ForEx, underlining the long term balance. In the medium term, rates would change in line with the upward movement of money supply & currency. In the long term, therefore, it complies with the neutrality principle.

Rahul Sunny answered 6 months ago

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