Problem 4 Suppose U.S. real money demand (Lug) is given by Lus = Lus (Rs; Yus) = 3YUS 4000133; where U.S. real income [Yusl U.S. nominal money supply [MUS], the U.S. price level [Pug], the euro area price level [Pew], the interest rate on euro-denominated deposits (Re), and the expected USD-EUR exchange rate E g [e are given by the following table. Yus Mus Pus Peur Re E/e 50 100 1 2/3 0.05 1.50 :1] Find the interest rate consistent with equilibrium in the U.S. money market. Hint: Set the real money supply (Mus/Pug] equal to real money demand and solve for R3;. 2 b) Using the expected exchange rate and interest rate you calculated in part a), nd the dollar price of a euro (Ewe) consistent with the UIP condition. Now suppose the US. money supply falls to 75. Assume that this increase is permanent such that the FX traders expect USD to depreciate: Eg/e = 1.125. c) What is the new interest rate in the US. money market in the short run [i.e., before prices adjust]? d) What is the new equilibrium spot exchange rate in the short run? e) Calculate the percentage change between the new short run spot rate from part d) and the old short run spot rate from part h] f) What is the new equilibrium interest rate in the U.S. money market in the long run [i.e., after prices adjust)? Hint: Your answer should be the same as in part a). g) What is the new equilibrium exchange rate in the long run (i.e_, after prices adjust)? Hinl: Use the UIP condition, the new exchange rate expectations, and the long run equilibrium interest rate you calculated in part f). h) What is the rate of exchange rate overshooting in the short run? Hint: Calculate the percentage change between the short run spot rate from part d] and the long run spot rate from part g]. SR LR Es/e E$/e LR Rate of overshooting: E$/e i) Does the spot exchange rate [E51g le] need to rise or fall [i.e., does the US. dollar need to depreciate or appreciate against the euro) from the short run to the long run equilibrium? What is an economic intuition behind this result? j) What is the equilibrium exchange rate if the increase in the money supply is transitory [i.e., if exchange rate expectations don't change and the price level does not change)