First of all, many thanks for the reply.
Actually the only variable in this relation which is corrected for inflation is "r" which is within the investment function "I". All the other variables are nominal. In Blanchard's terminology the "nominal exchange rate" or "E" is the relative price of domestic currency in terms of foreign currency, which is the common exchange rate which all of us are familiar with. Instead, the "real exchange rate" or "e" (epsilon in greek alphabet), is the relative price of domestic goods in terms of foreign goods and it's formula is: e = EP/P*
e = real exchange rate
E = nominal exchange rate
P = domestic price level (domestic GDP deflator)
p* = foreign price level (foreign GDP deflator)