(solution) Suppose there are only two countries, Home and Foreign, in the

(solution) Suppose there are only two countries, Home and Foreign, in the

Suppose there are only two countries, Home and Foreign, in the world. Owing to a verycold winter, Foreign experiences a major crop failure. As a result, the Foreign output level drops. Fortunately, the bad weather only affects the country temporarily, so the market participants do not change their expectations on the exchange rate between domestic currency and foreign currency. However, this reduction in the foreign output causes the spot exchange rate to change immediately. The Home country?s central bank does not want the spot exchange rate to change, what action should the Home central bank take to stabilize movements in the spot exchange rate in the short run?Answer this question in the context of the asset approach to the exchange rate and support your answer by a set of appropriate diagrams (i.e., the one that has foreign exchange market on the top and the domestic money market at the bottom).