Suppose interest parity does not hold exactly, but the true relationship is where is a term measuring the differential riskiness of domestic versus foreign deposits. Suppose a permanent rise in...

Suppose interest parity does not hold exactly, but the true relationship is

where
is a term measuring the differential riskiness of domestic versus foreign deposits. Suppose a permanent rise in domestic government spending, by creating the prospect of future government deficits, also raises
, that is, makes domestic currency deposits more risky. Evaluate the policy’s output effects in this situation.