1. Monetary Approach, Level Shocks. Consider a world in which the prices of goods are perfectly...

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1. Monetary Approach, Level Shocks. Consider a world in which the prices of goods are perfectly flexible and APPP holds continuously. This world has two countries, the U.S. and Mexico. The real interest rate is equal to 2% and it is fixed on world markets. Suppose the money growth rate is 2% in the United States and 5% in Mexico. Real GDP in both countries is growing at a 1% rate. Where possible give percent changes in your answers. a. Now suppose that at time T, Mexico's expected GDP growth rates falls to 0. What is the effect of the shock on the Mexican nominal interest rate and exchange rate at time T? b. Suppose that at time T there is a one-time jump in Mexico's money supply of 5% but expectations for the future change in money growth are unchanged. What is the effect of the shock on Mexico's nominal interest rate and exchange rate? 1. Monetary Approach, Level Shocks. Consider a world in which the prices of goods are perfectly flexible and APPP holds continuously. This world has two countries, the U.S. and Mexico. The real interest rate is equal to 2% and it is fixed on world markets. Suppose the money growth rate is 2% in the United States and 5% in Mexico. Real GDP in both countries is growing at a 1% rate. Where possible give percent changes in your answers. a. Now suppose that at time T, Mexico's expected GDP growth rates falls to 0. What is the effect of the shock on the Mexican nominal interest rate and exchange rate at time T? b. Suppose that at time T there is a one-time jump in Mexico's money supply of 5% but expectations for the future change in money growth are unchanged. What is the effect of the shock on Mexico's nominal interest rate and exchange rate?