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Explain briefly the short-run effects of the following policies in the following policies in the FX...

Explain briefly the short-run effects of the following policies in the following policies in the FX and money market, using the relevant economic equilibrium conditions in your explanation.

Suppose the Bank of Korea (South Korea's central bank) announces and implements a permanent decrease of its money supply.

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Answer #1

A permanent decrease in a country's money supply causes a proportional long run appreciation of its currency. The exchange rate is said to overshoot when its immediate response to a change is greater than its long run response or immediate effects on interest rates and exchange rates.

The decrease in the money supply is mirrored by an equal decrease in the nominal output, otherwise known as Gross Domestic Product ( GDP ). The decrease in the money supply will lead to a decrease in consumer spending. This decrease will shift the AD curve to the left.

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