Question 3 (25 points)
In a Keynesian world, suppose the U.S. conducts contractionary monetary policy. For the
purposes of this question, you can assume the rest of the world can be seen as one country.
Show your work also on a graph. Focus only on the short run.
a. (6 points) Using the IS-LM model, discuss how this policy would affect the real interest
and output in the U.S.
b. (6 points) Using a supply and demand analysis for the US dollar, explain how this affects
the nominal exchange rate, that is, whether the US dollar appreciates or depreciates.
c. (6 points) How does this affect the US net exports? Assume the effect of change in US
output on US net exports is stronger than the effect of the change in the exchange rate
on US net exports.
d. (7 points) Using the IS-LM model, discuss how this affects the output in the rest of the
world and the real interest rate.