Suppose that the demand function for real money balances in the domestic country is in logarithmic form as follows: mdt = + ,

with > 0, > 0, and > 0. mdt denotes the logarithm of nominal money demand, the logarithm ofthe price level, the logarithm of real income, the logarithm of real wealth, and the nominal interest rate. The corresponding real money demand function in the foreign country is as follows:

mdt*-pt*=yt*+wt*-Rt*

where * denotes magnitudes in the foreign country.

Using the flexible-price monetary model of the exchange rate answer the following questions:

a. Show that the current exchange rate of the domestic currency depends on the expected exchange rate. Comment on your findings (maximum 150 words)

b. Discuss whether in an economy experiencing very strong economic growth and a persistent current account surplus, and in which the domestic nominal interest rate is equal to the foreign nominal interest rate, it is possible to observe both a higher

growth of the domestic nominal money supply relative to the foreign one and an appreciating domestic currency (maximum 150 words).