Suppose instead, real GDP in the United States falls temporarily instead. Contrast the immediate effect of the temporary shock on interest rates and the exchange rate compared to the permanent shock.
a. Draw two diagrams with the money market diagram for the US on the left and the expected return in $/ exchange rate ($/yen) diagram on the right. Label the impact effect, when the shock is temporary, as point B and the impact effect when the shock is permanent as point C.
b. Why are these impact effects on the exchange rate different? Explain.
c.Assuming again that the shock to real GDP in the US was temporary, what would happen to the nominal interest rate in the US and the exchange rate in the long-run. Explain.