Consider two countries, Canada (Home) and US (Foreign). In 2018, Canada experienced relatively slow output growth (2%), whereas US had relatively robust output growth (4.2%). Suppose the Bank of Canada allowed the money supply to grow by 2% each year, whereas the Federal Reserve (Fed), the US central bank, chose to maintain relatively high money growth of 10% per year. For the following questions, use the simple monetary model (whereLis constant).

1. What is the inflation rate in Canada? In US? What is the expected rate of depreciation/appreciation in the Canadian dollar relative to the US dollar?
2. Suppose the Fed increases the money growth rate from 10% to 12%. If nothing in Canada changes, what is the new inflation rate in US?
3. Using time series diagrams, illustrate how this increase in the money growth rate affects the US money supply, interest rate, prices, real money supply, and exchange rate E$/C$over time. (Plot each variable on the vertical axis and time on the horizontal axis.)
4. Suppose the Fed wants to maintain an exchange rate peg with the Canadian dollar. What money growth rate would Fed have to choose to keep the value of the US dollar fixed relative to the Canadian dollar?
5. Suppose the Fed sought to implement policy that would cause the US dollar to appreciate relative to the Canadian dollar. What ranges of the money growth rate (assuming positive values) would allow the Fed to achieve this objective?
6. Next, consider the general monetary model, in which L is no longer assumed constant and money demand is inversely related to the nominal interest rate. In addition to the scenario described in the beginning of the question, the bank deposits in Canada pay 3% interest. Suppose the Fed increases the money growth rate from 10% to 12% and the inflation rate rises proportionately (one for one) with this increase. Using time series diagrams, illustrate how this increase in the money growth rate affects the US money supply, interest rate, prices, real money supply, and exchange rate E$/C$over time. (Plot each variable on the vertical axis and time on the horizontal axis.)