3. This question uses the general monetary model, where real money demand is inversely related to the nominal interest rate. Consider two countries, Japan and South Korea, where the currencies used are the Japanese yen and the Korean won, respectively. In 1996, Japan experienced relatively slow output growth (2%), while Korea had relatively robust output growth (7%). Suppose the Bank of Japan (Japans central bank) allowed the money supply to grow by 3% each year, while the Bank of Korea (South Koreas central bank) chose to maintain slightly higher money supply growth of 5% per year. In addition, bank deposits in Japan paid a nominal interest rate of iJ = 5%. You may further assume that real interest rates were equalized across these two countries.

You will find it easiest to treat Korea as the home country and Japan as the foreign country. Please use the approximated version of uncovered interest rate parity (UIP) below.

(c) Suppose the North Korean economy collapses suddenly, leading to re-unification with the South. As a consequence, unified Koreas output growth rate decreases from 7% to 3%. All else equal in Japan, what happens to the inflation rate in Korea, the nominal interest rate paid on Korean deposits, and the expected rate of depreciation of the Korean won due to this drop in output growth? Explain briefly with the help of the appropriate equation(s).