Question 4 (a) What is meant by 'news' in exchange-rate markets and why may this concept be important? [Use a simple formal statement for the definition.] [10 marks] (b) Using and developing appropriately the monetary model of the exchange rate, explain more specifically how 'news' matter. [14 marks] (c) Imagine that it is announced at time t that the domestic economy unexpectedly enters a recession that is anticipated to last until t+k (k>0). During the recession, domestic output will fall by x from its previous, normal level (a constant y, so that output will be y-x during the recession), but output will return to y from t+k+1 onwards. Using the model in (b), show how the actual exchange rate at t will differ from what was expected for the same at time t-1. [Hint: Consider how the recession is captured by the 'fundamentals' term z: in eq. (12.7) of the notes; and how the information about recession is captured by the 'news' eq. (12.17).] [9 marks]