'Following an announcement from the Riksbank (the Swedish central bank) of an interest rate increase, an immediate depreciation of the Krona was observed'. How can you explain this outcome? In your answer explain the economics of the UIP condition. Summarize your findings highlighting the role played by expectations and communication by the central bank. You are advised to take the following steps and in each case to draw a UIP diagram:

(a) Show the 'normal case' in which the central bank announcement is followed by an immediate appreciation of the Krona.

(b) Suppose the rise in the interest rate had been widely expected in financial markets. Show in the UIP diagram that there would be no immediate change in the exchange rate when the Riksbank made its announcement.

(c) Finally, show how an immediate depreciation in the Krona can be explained.