In our discussion of short-run exchange rate overshooting, we assumed real output was given. Assume instead that an increase in the money supply raises real output in the short run (an assumption that will be justified in Chapter 6). How does this affect the extent to which the exchange rate overshoots when the money supply first increases? Is it likely that the exchange rate undershoots? (Hint: In Figure, allow the aggregate real money demand schedule to shift in response to the increase in output.)

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