The solid lines illustrate the case when Home uses the short-term interest rate as its active policy tool, and keeps its balance sheet on hold, consistent with a desire to delay balance sheet normalization. The policy reaction is calibrated to be sufficiently aggressive that home GDP always remains at baseline (see column 2 of Table 1).
The higher policy rate path (that is, higher rc) causes the long-term interest rate (panel A) to rise, which in turn induces the real exchange rate to appreciate (panel B). The stronger currency and an expansion in domestic absorption (panel C) causes a deterioration in net exports (panel D).