Assume that an open economy Neverland is operating under a fixed exchange rate regime. Currently, Neverland’s economy is suffering a deep economic recession meaning that Neverland’s total output level is much lower than its medium-run output level. Neverland’s government is discussing how to bring the economy back to its medium-run output level. One side argues that the government should devaluate the currency; while the other side argues that the market itself will bring Neverland’s economy to its medium-run equilibrium.

a) Use an appropriate economic model to illustrate and explain the different policies mentioned above.

b) Discuss the main pros and cons of each policy option.