Groucho Marx, as Governor of Freedonia's central bank, has problems. He sees the value of his currency, the fdk, under constant attack from Rosor, a wealthy mutual-fund manager. Apparently, Rosor believes that the fdk will soon devalue from gbp 1.000 to 0.950.

(a) Currently, both gbp and fdk interest rates are 6% p.a. By how much should Groucho change the one-year interest rate so as to stabilize the spot rate even if Rosor expects a spot rate of 0.950 in one year? Ignore the risk premium-that is, take 0.950 to be the certainty equivalent.

(b) If the interest-rate hike also affects Rosor's expectations about the future spot rate, in which direction would this be? Taking into account also this second-round effect, would Groucho have to increase the rate by more than your first calculation, or by less?