2.Suppose there are two countries, Japan, and the United States. Prices are sticky in the short run, but perfectly flexible in the long run. PPP may fail in the short run but holds in the long run. Uncovered interest parity always holds. Initially the market is in equilibrium. At time T, there is a permanent increase in money supply in Japan.

a.(3 points). Using the two appropriate graphs (money and FX market), analyze how the increase in money supply in Japan affects the interest rate and exchange rate in Japan in the short run and in the long run.

b.(3 points). Using the two appropriate graphs (money and FX market), analyze how the increase in money supply in Japan affects the interest rate and exchange rate in the United States in the short run and long run.

c.(4 points). Using two figures, plot the trajectory of the Japanese nominal exchange rate and real exchange rate in the short run and long run.