In the past year inflation has been increasing in many countries. For simplicity, assume that there are only two countries in the World: Australia and the US. Their central banks adjust monetary policy rates to control inflation. However, inflation has recently grown significantly, from 3.5% to 5.1% in Australia and from 4.7% to 8.5% in the United States. The (nominal) short-term policy rates have been raised recently from 0.10% to 0.85% in Australia and from 0.25% to 0.75% in the USA. Consider the Australian Dollar (AUD) vs. the US Dollar (USD) and assume, for simplicity, that all the the rates in this long question are all annual:

1.What can you tell about the relationship between spot exchange rate and 1 year forward exchange rate based on the information about nominal interest rates alone?Explain your reasoning in words.

2. Calculate the (approximate) real interest rate in both countries and the real interest rate differential between Australia and the United States before and after the increase of inflation and interest rates. Compare the two countries and describe the change.