Assume there are only 2 countries in the world, Canada and Germany. Consider the model of exchange rate determination with short-run nominal rigidities and in which money market equilibrium holds every period, Uncovered Interest Rate Parity holds every period. Explain what happens to German and Canadian interest rates, German and Canadian prices, and the exchange rate (measured as units of Euro per one unit of Canadian dollar, E|$) in the short-, and long-run when the demand of Canadian dollars decrease . Support your answer with a graph of the German money market equilibrium and a graph of the foreign exchange market equilibrium. (hint: treat Canada as the domestic country and Europe as the foreign country and show the effects on the 4 quadrant graphs.

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