The following questions are based on fixed exchange rate and/or flexible exchange rate regime from the perspective of macroeconomic policy implications in an open macroeconomic model. The answers must be written in your words along with graphical illustration, if appropriate. Without explaining in your words, the graphical illustration alone will not be credible. Also make sure you use the relevant symbols and notation on each of the lines and axis on the graph(s) to clearly indicate the working mechanism of variables.
a. Assume a country is in a fixed exchange rate regime such as China. Explain what factors might cause individuals to expect that a country will devalue its currency. Explain the various actions that policy makers can choose in response to this expected devaluation.
Hint: As part of your answer, you may give the example of the most recent (Aug 11 and 12, 2015) devaluation of Chinese currency (Yuan or Renminbi) by more than 2% against its major composite currency index.
b. Assume a country is in a fixed exchange rate regime. Now suppose that individuals expect that policy makers will devalue its currency. Explain the various actions that policy makers can choose in response to this expected devaluation.