1. Describe what will happen to Home's economytoday, assuming that the central bankkeeps the money supply fixed both today and in the future. (2 pts)
2. Now suppose that the Home central bank has the goal of stabilizing real output Y rather than the money supply.Describe the actions it will take, todayand in the future, in order to fix Y and the implications for the exchange rate and interest rates. (2 pts)
3. Assume Purchasing Power Parity (PPP) holds in the long run between the U.S. and Europe.What does this already imply for the exchange rate?Write down your answer in the form of an equation and a brief explanation. (2 pts)
4. Now assume we have PPP and also that the quantity theory of money holds, with the velocity of money V constant and real output Y fixed and constant in both countries.Suppose that the Federal Reserve is expanding the supply of dollars by 5% per year, while the European Central Bank is expanding the supply of euros at 2% a year.What will happen toexchange rate over time? Give a quantitative answer and a brief explanation. (2 pts)