3. Long-run exchange rate model (based on PPP) (a) Write down the fundamental equation of the...

3. Long-run exchange rate model (based on PPP)

(a) Write down the fundamental equation of the monetary approach to the exchange rate.

(b) Using the above equation explain how a change in domestic interest rate affects the long-run level of exchange rate. Compare the prediction of this model with prediction of the interest rate parity.

(d) Explain how Fisher effect allows us to reconcile the monetarist approach to the exchange rate with the approach based on the interest rate parity.

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