Suppose that the short-term nominal interest rate–the one the central bank actually controls–is 3%.

c)  Consider again the initial equilibrium before the foreign recession. Suppose there is an increase in the demand for real money balances in this economy that shifts the LM curve to Y=$88 + $10,000 (r+πe), (iii)while the IS curve is given by (ii). On a diagram show how this will shift the LM

curve. What will be the new equilibrium interest rate and output? (7 points)

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