Consider the uncovered interest parity condition we showed in class: E= 1+iEe

1+i?

Consider the uncovered interest parity condition we showed in class: 1+ E: 1+3\" EB where E is the nominal exchange rate, measured in foreign currency per unit of domestic currency, E'3 is the expected exchange rate, 1' is the domestic nominal interest rate and 1"\" is the foreign nominal interest rate. a. Derive an expression that show the domestic nominal interest rate as a function of everything else, particularly the nominal exchange rate. b. Sketch the relationship between the nominal interest rate and the exchange rate in a graph, having E on the horizontal axis. What happens in this graph if the expected exchange rate rises, that is the domestic currency is expected to appreciate? Draw two graph side-by-side for each of the following scenarios. The left graph should be money market (or market for real money balances), the right graph shows the uncovered interest parity condition from the previous part. Interest rate movements should align in both graphs. Show an initial equilibrium in the money market and the implied exchange rate. Then add the effects of an decrease in income for each of the following: 1. the central bank chooses the money supply independently of the interest rate. 2. the central bank keeps interest rates xed at a specic target. What happens to the nominal exchange rate in each case