Use the money market with the general monetary model, and foreign exchange (FX) market to answer the following questions. The questions consider the relationship between the U.K. pounds () and the Australian dollar ($). Let the exchange rate be defined as Australian dollars per 1 U.K. pound, E$/. In the U.K., the real income (Y) is 1.5 trillion, the money supply (M) is 1.5 trillion, the price level (P) is 2, and the nominal interest rate (i) is 10.0% per annum. In Australia, the real income (Y$) is 1.0 billion, the money supply (M$) is AU$2.0 billion, the price level (P$) is AU$4.0, and the nominal interest rate (i$) is 10.0% per annum. These two countries have maintained these long-run levels. Thus, the nominal exchange rate (E$/) has been 2.00. Note that the uncovered interest parity (UIP) holds all the time and the purchasing power parity (PPP) holds only in the long-run. Assume that the new long-run levels are achieved within 1 year from any permanent changes in the economies. Now, today at time T, the Reserve Bank of Australia raises the money supply (M$) to AU$2.1 trillion by 5% permanently. Assume that Y, M, and Y$ do not change at all. Use the approximation for the uncovered and covered interest parities if necessary.

(a) Calculate the Australian price level in 1 year (the new long-run price level in Australia at T+1), Pe$ (round to 3 decimal places). (2 marks)

(b) Calculate the new expected exchange rate in 1-year (new long-run level of the exchange rate), Ee$/. (2 marks)

(c) With the new money supply, the interest rate in Australia fell to 5.0% per annum today. Calculate the new exchange rate today, E$/.