True or False?
The right answer is false. Equilibrium is determined by the intersection of IS and ZZ. Under full employment, these curves determine equilibrium P with Y = YF. These levels of P and YF, together with the internationally determined real interest rate and the expected rate of inflation, determine the quantity of money demanded. If the supply of money does not equal this quantity, domestic residents will achieve portfolio equilibrium by adjusting their holdings of non-monetary assets. The authorities are forced to provide the public's desired money stock by exchanging domestic base money and foreign exchange reserves. Thus, an increase in the price level leads to a proportional increase in the nominal money stock, not the other way around.
The domestic price level will change whenever the aggregate demand for domestic goods changes. This can occur as a result of exogenous shifts of domestic consumption, investment, or net exports, or changes in the price level or interest rates in the rest of the world. The domestic authorities are forced to finance these changes in the domestic price level by supplying the approprate quantity of money. It is true that an increase in the money supply in the rest of the world will lead to a proportional (more or less) increase in the world (including the domestic) price level. But the domestic nominal money supply will respond passively to these world-wide changes---domestic money supply changes do not cause changes in the domestic price level.