You may assume that there are open capital

markets, and that prices are sticky in the short run but perfectly flexible in the long run. For full marks, be sure to label any diagrams clearly and completely.

4. (20 points)

Consider a world with two countries, Thailand and Canada. At a given point in time, there

is a permanent decrease in Thailand's money supply. Assume that nothing else in the

Canadian and Thai economies changes.

a) What happens to EB/$, the baht-dollar exchange rate, in both the short-run and longrun?

Explain your answer in words and by using whatever figures and equations you

find appropriate.

b) Is the short-run exchange rate EB/$ above or below the expected long-run exchange

rate? Explain the dynamics of the exchange rate over time with the help of a diagram.