In 2016, the Bank of Japan made a surprise move and introduced a negative interest rate for commercial banks. The benchmark of0.1% means that commercial banks will be charged by the central bank for some deposits. This policy is designed to encourage banks to use their reserves to lend to businesses in an attempt to counter Japan's economic stagnation. Facil- itated access to credit makes more money available to the private sector for any given money supply choice of the central bank. This leads to apermanentincrease in money supply.

a. (5 Points) Use a diagram showing the exchange rate, expected cur- rency returns and money holdings to analyze the short-term effect of apermanentincrease in money supply on the nominal Japanese interest rate and the nominal spot exchange rate.

b.(5 Points) What is thelong-termresponse of the nominal spot ex- change rate? Is there overshooting?