2. Use the DD-AA model to analyze the impact of a transitory decrease in the Foreign interest rate R* on the domestic economy. (Use the "standard" DD/AA model where changes in the interest rate have no effect on the DD curve.). Note: You can use one (large!) diagram to answer questions (a) and (b).

(a) If the country operates with a flexible exchange rate regime what impact will this have on the country's exchange rate E, level of domestic output Y, and the level of the country's Current Account (CA) balance? Briefly explain.

(b) If the country operates with a fixed exchange rate regime what impact will this have on the country's money supply M, level of domestic output Y, and the level of the country's Current Account (CA) balance? Briefly explain.