Exercise 7 Consider a situation where the defense of a fixed exchange rate regime can, at the limit, result in default of the foreign debt for a given country. In this case, international investors who possess assets from this country can decide in one of two ways: panic and sell all assets from this country, or keep the assets while believing the country will not become insolvent.

In turn, the government can announce a default of the debt or continue paying its financial obligations. In the case of default, the exchange rate begins to float freely. Such interaction between the government and investors can be modeled as a noncooperative game described by the following normal-form representation:

Government Default Payment Investors Panic 2 x, 2 x 2 0.75x, 22x Maintain 2 2x, 2 0.75x x, x The amount x can be interpreted as a financial amount resulting from a given equilibrium.

a. Interpret the strategies of each agent and the possible results due to the interaction between the private investors and government.

b. Find the possible equilibria for this game.

c. What can be said regarding the equilibria found in the previous item? Would it be possible to create a mechanism with the goal of avoiding the bad equilibrium and conduct the economy toward a good equilibrium? Explain your answer, describing the mechanism, if such be the case.