Suppose Mexico wishes to fix its exchange rate relative to the U.S. dollar.
(a) If the Federal Reserve raises interest rates, what would happen to the peso-dollar exchange rate in the absence of any change in Mexican interest rates?
(b) Suppose Mexico wants to keep its interest rate fixed no matter what, maintain a fixed exchange rate, and allow open capital markets. What will happen when the United States raises interest rates?
(c) Summarize what you learn from this exercise.