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Questions 25 and 26 Please draw the graphs of exchange rates(E$/¥) and interest rates(iUS) using the following figure for the Question 25 and Question 26 (vertical and horizontal axis should be the same as given figures)

nterest rate. Exchange Rate, Es/ 1 0

25 (8 points) US and Japanese interest rates are both equal to 0.25% a year and ES/Y- 0.01. Assume foreign exchange and domestic money markets are initially in equilibrium The Federal Reserve announces (at to) an unexpected temporary contraction of the US money supply for the next three months the money supply will be 2% lower, before returning to its initial level in three months (ti). Graph the response of US interest rates and the S-Y exchange rate over the next three months, assuming that Japanese monetary policy does not change in response to the Feds announcement and that investors believe the Feds commitment to increase the money supply in the future. 26. (8 points) At the end of the three month period (t1), the Fed announces that in fact it will not reverse its reduction of the money supply, which will be permanently 2% lower. Repeat your graph from Question 29, extending it forward in time to shovw the expected response of US interest rates and the exchange rate over th<e year following the second announcement, assuming again that there is no change in Japanese policy and the Fed is expected to abide by this new policy

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