In our discussion of short-run exchange rate overshooting, we assumed that real output was given. Assume instead that an increase in the money supply raises real output in the short run (an assumption that will be justified in Chapter 16). How does this affect the extent to which the exchange rate overshoots when the money supply first increases? Is it likely that the exchange rate undershoots? A. Since the increase in output will increase the demand for money, the interest rate will not increase as much; thus, the overshoot will be smaller. The only way for the exchange rate to undershoot is if the interest rate decreases when the money supply increases. B. Since the increase in output will increase the demand for money, the interest rate will not fall as much; thus, the overshoot will be smaller. The only way for the exchange rate to undershoot is if the interest rate rises when the money supply increases. C. Since the increase in output will increase the demand for money, the interest rate will decrease more; thus, the overshoot will be larger. The only way for the exchange rate to undershoot is if the interest rate rises when the money supply increases. D. Since the increase in output will decrease the demand for money, the interest rate will not fall as much; thus, the overshoot will be smaller. The only way for the exchange rate to undershoot is if the interest rate rises when the money supply increases.