Question 1 (10 points) Consider two countries: Brazil and South Africa. In the year T Brazil experienced relatively slow output growth (1%), whereas South Africa had relatively high output growth (5%). Suppose the Central Bank of Brazil allowed the money supply to grow by 2% each year, while the South African Reserve Bank chose to maintain money growth of 10% per year. Use the simple monetary model (where L is constant). You may find it easier to treat South Africa as the home country and Brazil as the foreign country.

1.1. What is the inflation rate in South Africa? In Brazil? Show your calculations.

1.2. What is the expected rate of depreciation of the South African Rand relative to the Brazilian Real? Show your calculations.

1.3. Suppose the South African Reserve Bank decreases the money growth rate from 10% to 8%. If nothing in Brazil changes, what is the new inflation rate in South Africa?

1.4. Suppose the South African Reserve Bank wants to maintain an exchange rate peg with the Brazilian Real. What money growth rate would the South African Reserve Bank have to choose to keep the fixed exchange rate of the Rand relative to the Real? (3 points)

1.5. Suppose the Central Bank of Brazil would like to achieve depreciation of Brazilian Real against the South African Rand. Assuming the initial conditions of this question for both countries, what range of the money growth rate would allow the Central Bank of Brazil to achieve it?