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4) Using the diagram that illustrates an equilibrium in the asset market initially introduced in chapter...

4) Using the diagram that illustrates an equilibrium in the asset market initially introduced in chapter 15, graphically illustrate how the Fed can keep the exchange rate fixed when the German money supply decreases.   

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Answer #1

The decrease in the money supply will increase rate of interest in the Germany, thus there will be a outflow of fund from USA to the Germany. The net export of USA will decline and IS curve will shift to down there reducing the exchange rate.

Now to keep the exchange rate fixed, the federal reserve will reduce the money supply.it would shift the LM curve to left and economy comes to the previous exchange rate but gdp level will decline here.

Following is the diagram :

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