a)Suppose there is a permanent change in the preference of domestic residents such that they decide to consume less goods and services for all levels of income. Knowing that you are an expert in international finance, the government hires you to study about which exchange rate regime the country should adopt to minimize fluctuations in output. What kind of advice would you give to the government? Explain in words and in a DD-AA diagram.

b) Consider an economy that adopts a floating exchange rate, it is currently operating above its long-run capacity and is running a current account deficit. The country wants to get back to its long-run production capacity and to correct its current account, what kind of policy should the policy makers pursue in the short run? Use DD-AA model to support your answer.