8. This question uses the general monetary model, where L is no longer assumed constant, and money demand is inversely related to the nominal interest rate. Consider the same scenario described at the beginning of the previous question. In addition, the bank deposits in Japan pay a 3% interest rate, i¥ = 3%.

a. Compute the interest rate paid on South Korean deposits.

b. Using the definition of the real interest rate (nominal interest rate adjusted for inflation), show that the real interest rate in South Korea is equal to the real interest rate in Japan.

(Note that the inflation rates you computed in the previous question will be the same in this question.)

c. Suppose the Bank of Korea decreases the money growth rate from 15% to 12% and the inflation rate falls proportionately (one for one) with this decrease. If the nominal interest rate in Japan remains unchanged, what happens to the interest rate paid on South Korean deposits?

d. Using time series diagrams, illustrate how this decrease in the money growth rate affects the money supply MK; South Korea’s interest rate; prices PK; real money supply;

and Ewon/¥ over time. (Plot each variable on the vertical axis and time on the horizontal axis.)