196
MACROECONOMICS
pushing the economy along the arrowed paths so that the system moves from
point J to K, from b back to a, and from C down to A. The reinstatement of the
original equilibrium is possible because the money supply has contracted to
the point where it is once more at its initial level
M
s
0
due to a loss of foreign
exchange reserves to the extent KH.
The important thing to note is that as long as the government has reserves
left, the domestic money supply is determined by the portfolio preferences of
domestic residents. With the exchange rate fixed and output given, and perfect
foresight, the demand for holding money ...
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