Consider our example of overshooting shown in given figure, in which the domestic money supply increased by 10 percent.
Assume that the path of slow adjustment of prices is that the price level rises by about 2 percent per year for five years. What would the path of the nominal exchange rate be if PPP held for each year?
Given the actual path for the exchange rate shown in given figure, does PPP hold in the short run? Does it hold in the long run?
