Assume instead, real GDP in United States falls temporarily instead. Contrast the instantaneous effect of temporary shock on interest rates and exchange rate compared to the permanent shock.
a. Sketch two diagrams with the money market diagram for US on the left and expected return in $/ exchange rate ($/yen) diagram on right. Label the impact effect, when the shock is impermanent, as point B and the impact effect when shock is permanent as point C.
b. Why are these impact consequences on the exchange rate dissimilar? Describe.
c. Supposing again that the shock to real GDP in US was impermanent, what would take place to the nominal interest rate in US and the exchange rate in the long-run? Discuss.