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246 CHAPTER 8. THE MUNDELL-FLEMING MODELCollecting the equations that form the ßexible-price solution wehavey t = y t−1 + z t = y(z t ),˜q t = y t − d t γσ+η η(η + σ) δ t =˜q(z t , δ t ),˜p t = m t − y t + αδ t =˜p(z t , δ t ,v t ).The system displays a triangular structure in the exogenous shocks.Only supply shocks affect output, demand and supply shocks affectthe real exchange rate, while supply, demand, and monetary shocksaffect the price level. We will revisit the implications of this triangularstructure in Chapter 8.4.Disequilibrium DynamicsTo obtain the sticky-price solution with 0 < θ < 1, substitute thesolution (8.34) for ˜p t into the price adjustment rule (8.20), to getp t = m t−1 −y t−1 +θ[v t −z t +αδ t ]. Next, add and subtract (v t −z t +αδ t )to the right side and rearrange to getp t =˜p t − (1 − θ)[v t − z t + αδ t ]. (8.36)The gap between p t and ˜p t is proportional to current information(v t − z t + αδ t ), which we’ll call news. You will see below that thegap between all disequilibrium values and their shadow values are proportionalto this news variable. Monetary shocks v t and demand shocksδ t cause the price level to lie below its equilibrium value ˜p t while supplyshocks z t cause the current price level to lie above its equilibriumvalue. 9 Since the solution for p t does not depend on lagged values ofthe shocks, the deviation from full-price ßexibility values generated bycurrent period shocks last for only one period.Next, solve for the real exchange rate. Substitute (8.36) and aggregatedemand from the IS curve (8.17) into the LM curve (8.18) to9 The price-level responses to the various shocks conform precisely to the predictionsfrom the aggregate-demand, aggregate-supply model as taught in principlesof macroeconomics.