(A). Explain the exchange rate over-shooting hypothesis. [5 points]

(B). Figure 2: Simultaneous Equilibrium in the U.S. Money Market and the Foreign Exchange Market Dollar/euro exchange rate, Eye Return on dollar deposits Foreign exchange Eye market Expected return on euro deposits Rates of return (in dollar terms) L(Rg. Yus) U.S. real Money Mus money market Pus supply (increasing) U.S. real money holdings Both asset markets are in equilibrium at the interest rate R and exchange rate E]; at these values, money supply equals money demand (point 1), and the interest parity condition holds (point 1'). What are the short run and long run effects of a permanent increase in U.S. money supply? Assume that the U.S. real national income is constant. [5 Points]