On May 4, 2022, the Federal Reserve (the Fed) raised its benchmark interest rate by half a percentage point, which was the largest rate hike in two decades. The Fed also mentioned it has already started selling off the trillions of dollars of bonds on its books. In addition, the market expects the sell off of bonds (or more rate hikes) for the rest of the year until the inflation rate gets back to its target range.
In the context of the asset approach to the exchange rate, examine the short-run and long-run effects of the above news on the C$/US$ exchange rate and real money balance in Canada. Explain in words and ONE foreign exchange market diagram (only the first diagram will be graded).
Note:
1) Use the subscripts "C" and "US" to represent all the variables and terms used for Canada and the U.S. respectively in your written explanation and diagram. Also, DO NOT ANSWER the question by stating let the C$ be DC and the US$ be FC. You are required to follow the notations used in the question.
2) Compare your answer to initial long-run equilibrium.