considers long-run policies in Mexico relative to Canada. Assume Mexico's money growth rate is currently 4% and its inflation rate is 2%. Canada's money growth rate is 6% with 3.25% inflation rate. The world real interest rate r* is 0.75%. For the following questions, use the conditions associated with the general monetary model. Treat Mexico as the home country and define the exchange rate as Mexican pesos per Canadian dollar, Epeso/C$
d) Suppose that Mexicos central bank wants to maintain a fixed exchange rate against the Canadian dollar. Assuming that nothing in Canada changes, what must the central bank do to achieve this long run objective? What money growth rate for Mexicos money supply will make this possible?
e) Calculate Mexicos new inflation rate and nominal interest rate after this policy is implemented.
f) Now suppose that Canadas inflation rate increases from 3.25% to 5%. If Mexico wants to maintain the fixed exchange rate, what will happen to its inflation rate?