Question: Initially, both Home and Foreign are in their long-run equilibrium. Home's level of money supply is constant (no growth in money supply), and Foreign has

Initially, both Home and Foreign are in their long-run equilibrium. Home's level of money supply is constant (no growth in money supply), and Foreign has a monetary growth rate of 4%. Output growth rates in both countries are the same and equal to 2%. In attempt to stop deflation, Home central bank increases the growth rate of money supply to 4% at time T0. According to the monetary approach to the exchange rate, what would the domestic inflation be after time T0? Is domestic currency expected to appreciate or depreciate after time T0? At what rate? Explain with the aid of the diagrams that show the time paths of MS, R, P and E for Home (make sure you include numbers in your written and graphical explanations.)

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