This question uses the general monetary model, where L is no longer assumed constant, and money demand is inversely related to the nominal interest rate. Consider the same scenario described at the beginning of the previous question.(Consider two countries: Japan and Korea. In 1996 Japan experienced relatively slow output growth (1%), while Korea had relatively robust output growth (6%). Suppose the Bank of Japan allowed the money supply to grow by 2% each year, while the Bank of Korea chose to maintain relatively high money growth of 12% per year). In addition, the bank deposits in Japan pay a 3% interest rate, i¥ = 3%.

a. Compute the interest rate paid on Korean deposits.

b. Using the definition of the real interest rate (nominal interest rate adjusted for inflation), show that the real interest rate in Korea is equal to the real interest rate in Japan.

c. Suppose the Bank of Korea increases the money growth rate from 12% to 15% and the inflation rate rises proportionately (one

for one) with this increase. If the nominal interest rate in Japan remains unchanged, what happens to the interest rate paid on Korean

deposits?

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