There was a vigorous debate among economists in Canada on whether Canada should form a currency union with the U.S. Now, suppose that Canadian economists agree that the Canadian dollar (C$) should be fixed to the U.S. dollar (US$).

Shortly after fixing the C$ to the US$, there is a temporary increase in the European Union (EU) demand for the U.S. exports but not for the Canadian exports.

a) How are the Canadian current account and output affected in the short run and why? Use words and diagrams to support your answer. (Hint: Your diagrams should consist of 2 markets, one for the Canadian market and the other for the U.S. market) (12 points)

b) What kind of macroeconomic policy could the Canadian government undertake to offset the impact on Canadian output level? (Use words to explain your answer only) (3 points)