Money Market and Exchange Rate

(1) Explain how the money markets of two countries are linked though the foreign exchange market.

(2) The following Figure shows the effect on the Dollar/Euro exchange rate and the Dollar interest rate after an increase in the U.S. money supply. Please explain why the dollar depreciates against the euro in this case.

Dollar/euro exchange rate. Este Dollar return 21 ES Expected euro return Rates of return (in dollar terms) R L(R. YUS) MJ Pus MUS Increase in u.s. real money supply Pus U.S. real money holdings Windows'u Et