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Unformatted text preview: money demand, leaving all relative prices, output and the nominal interest rate the same and apreciation the domestic currency in proportion to the increase in real money demand. The long run level balances is M/P 2 , a level where the interest rate in the long run equals its initial value. The dynamics of adjustment to a permanent increase in money demand are from the initial point where exchange rate is E1, immediately to point where the exchange rate is E3, and then, as the price level falls over time, to the new long run position with an exchange rate of E4. R L2 L1 E1 E4 E2 E3...
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- Spring '10