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8.3. A STOCHASTIC MUNDELL—FLEMING MODEL 245Substitute (8.31) and (8.30) into (8.29) to getb 1 m t + b 2 y t + b 3 d t + b 4 δ t= m t − y t1+λ + λγ(1 + λ)(η + σ) δ t (8.32)λ+1+λ [b 1m t + b 2 y t + b 3 (d t − γδ t )].Equate coefficients on the variables to getb 1 = 1 = −b 2 ,b 3 = 0,b 4 =λγ(1 + λ)(η + σ) . (8.33)Write the ßexible-price equilibrium solution for the price level as˜p t = m t − y t + αδ t , (8.34)whereλγα =(1 + λ)(η + σ) .A supply shock y t generates shadow deßationary pressure whereas demandshocks δ t and money shocks m t generate shadow inßationarypressure.The shadow nominal exchange rate can now be obtained by adding˜q t +˜p t˜s t = m t +Ã1 − ηη!y t − d Ã!t γση + η(η + σ) + α δ t . (8.35)Positive monetary shocks unambiguously lead to a nominal depreciationbut the effect of a supply shock on the shadow nominal exchange ratedepends on the magnitude of the expenditure switching elasticity, η.You are invited to verify that a positive demand shock δ t lowers thenominal exchange rate.