Suppose that the demand function for real money balances in the domestic country is in logarithmic form as follows: mdt−

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Suppose that the demand function for real money balances in the
domestic country is in logarithmic form as follows: mdt− 𝑝𝑡 = 𝜂𝑦𝑡 +
𝛾𝑤𝑡 − 𝜎𝑅𝑡,
with 𝜂> 0, 𝛾 > 0, and 𝜎 > 0. mdt denotes the logarithm
of nominal money demand, 𝑝𝑡 the logarithm of𝑡𝑡the price level, 𝑦𝑡
the logarithm of real income, 𝑤𝑡 the logarithm of real wealth, and
𝑅 the nominal interest rate. The corresponding real money demand
function in the foreign country is as follows:
mdt*-pt*=ηyt*+γwt*-σRt*
where * denotes magnitudes in the foreign country.
Using the flexible-price monetary model of the exchange rate
answer the following questions:
a. Show that the current exchange rate of the domestic currency
depends on the expected exchange rate. Comment on your findings
(maximum 150 words)
b. Discuss whether in an economy experiencing very strong
economic growth and a persistent current account surplus, and in
which the domestic nominal interest rate is equal to the foreign
nominal interest rate, it is possible to observe both a higher
growth of the domestic nominal money supply relative to the
foreign one and an appreciating domestic currency (maximum 150
words).