Consider a period when, prior to euro entry, the central bank of Lithuania maintained an exchange rate band relative to the euro, at the time this was a prerequisite for joining the Eurozone. The rule said that Lithuania had to keep its exchange rate litas per euro at a constant level. Euro area experienced relatively slow output growth (1%), whereas Lithuania had relatively robust output growth (6%). Suppose the European central bank allowed the money supply to grow by 3% each year, whereas the central bank of Lithuania chose to maintain a relatively high money growth of 10% per year.

A. What is the inflation rate in Lithuania? In Euro? 

B. Calculate the rate of depreciation in the Lithuanian litas relative to the euro. 

C. Is Lithuania qualified to join the Euro? What could the central bank of Lithuania do to maintain the exchange rate band required by the Euro? 

D. Suppose that output growth of the Euro area slows down to 0%. What should the central bank of Lithuania do to maintain the exchange rate band required by Euro? 

E. Due to economic slack in the euro area, the European central bank decided to increase the growth rate of the money supply to 5% which results in 1% income growth. Then, what should the central bank of Lithuania do to maintain the exchange rate band required by Euro)?