6. Suppose the domestic interest rate it = io for any t. There will be a transitory increase in it+1 that will last for two periods, i.e., it+1 = +2 = io +. Otherwise it stays at io. Do the same analysis as in class to forecast the behavior of the exchange rate between US and Euro (number of dollars per euro) and draw the graphs of both the interest rate differential and the exchange rate. Consider two cases: (a) The t+1 shock is announced at time t (b) The t+1 shock is not announced at time t but it is a surprise

6. Fixed exchange rates Consider the exchange rate between the Moroccan dirham and the euro. Suppose the Moroccan government and the Eurozone governments agree to fix the exchange rate at 1.25 dirham per euro, as shown by the grey line on the following graph. Refer to the following graph when answering the questions that follow. EXCHANGE RATE (Dirham per euro) 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0 02 4 6 8 12 QUANTITY OF EUROS (Billions) Supply of Euros Demand for Euros 10 14 At the official exchange rate of 1.25 dirham per euro, the euro is 16 (? , and the Moroccan dirham is I which means