1. Assume that prices are sticky in the short run. Use the MM-FX model to demonstrate the effects of the following events. Display the time paths of the short-term interest rate on Swiss franc denominated assets and the Swiss franc-euro exchange rate. Explain your reasoning and answer whether there is exchange rate overshooting.
a. The Swiss National Bank, which is the central bank of Switzerland, purchased Swiss government bonds for 2 million francs and sold the bonds to commercial banks for 2 million francs one month later.
b. The Swiss National Bank, which is the central bank of Switzerland, purchased Swiss government bonds for 2 million francs and permanently kept the bonds.
c. The Swiss National Bank, which is the central bank of Switzerland, announced that it will purchase Swiss government bonds for 2 million francs next month, and permanently kept the bonds.
d. Suppose you observe that the short-term interest rate on Swiss-franc denominated bonds increased without changes in the short-term interest rate on euro denominated bonds, and the Swiss franc depreciated against the euro.
2. Hong Kong's monetary authority fixes exchange rates against the US dollar and maintains free capital mobility. Assume that goods prices are sticky in the short run.
a. Is the set of policies chosen by Hong Kong's monetary authority consistent with the Trilemma? Explain your reasoning.
b. Suppose the European Central Bank lowers the euro short-term interest rate for 3 months. How will this policy affect Hong Kong's exchange rate between Hong Kong and the euro zone? Explain your reasoning.