Discuss the impact of a surplus in the balance of payments of a country on its domestic currency if the country has a fixed exchange rate regime.
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a. Assume a country is in a fixed exchange rate regime such as China, explain what factors might cause indiciduals to expect thata country will devalue its currency. Explain the various actions that policy makers can choose in response to this expected devaluation.
b. assume a country is in a fixed exchange rate regime. Now suppose that individuals expect that policy makers willdevalue its currency (yuan or renminbi)by more that 2% against its major composite currency index.
c. suppose the economy is operating below the natural level of output. Discuss the arguments for and against using devaluation in such a situation.
d. suppose the economy is initially operating above the natural level of output. In a fixed exchange rate regime, explain how the economy will adjust to this situation.
2 a) Describe two reasons why a country may be facing a Balance of Payments (BOP) deficit. (20 points)
2 b) What is the Official Reserves Account (ORA) and why is it more important for countries under a fixed exchange rate regime than for those under a floating exchange rate regime? (20 points)
What should a country do if it decides to follow a fixed exchange rate? And what are the advantages or disadvantages of a fixed exchange rate regime?