Question
Consider two small open economies, Canada and Mexico, and the exchange rate is quoted as EC$/Peso. Suppose money demand increases temporarily in both Canada and
Consider two small open economies, Canada and Mexico, and the exchange rate is quoted as EC$/Peso. Suppose money demand increases temporarily in both Canada and Mexico at the same time.
a) In the context of the asset approach to the exchange rate, what happens to the C$/Peso exchange rate in the short run? Explain in words and ONE foreign exchange market diagram
b) In the context of the monetary approach to the long-run exchange rate, what happens to the C$/Peso exchange rate in nominal terms? (5 points).
Note: Use the subscripts "C" and "M" to represent all the variables and terms used for Canada and Mexico respectively in your written explanation.
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