Chapter 17.2 Flashcards
Comparing and Contrasting Exchange Rate Systems
How does the degree of certainty for stakeholders differ from the fixed to floating exchange rates?
-Under fixed exchange rate systems, there is a high degree of certainty for firms, consumers and government. This makes it easier to plan, and easier to calculate accurately prices of goods and services in different countries
-Under floating exchange rate systems, there is a low degree of certainty. This has negative effects on trade as well as investment flows. In addition, abrupt changes in exchange rates will cause financial crises.
Comparing and Contrasting Exchange Rate Systems
How does the role of foreign currency reserves differ from fixed to free floating systems?
-Under fixed exchange rate systems, central bank should have sufficient amount of foreign currency reserves, however problems may rise if central bank do not have enough reserves to carry out necessary interventions
-Under free floating exchange rates, there is no need for central bank to intervene
Comparing and Contrasting Exchange Rate Systems
How does the correction of current account balance differ from fixed to free floating exchange rate systems?
-Under fixed exchange rate systems, there are no easy methods to correct imbalances. If reserves are not available, then government must resort to contractionary policies and trade protection, which have negative consequences
-Under free floating exchange rate systems, it is easier as it is more flexible and has the ability to automatically adjust to excess demand or supply of currency, thus bringing about a balance in the balance of payments
Comparing and Contrasting Exchange Rate Systems
How are the effects on inflation different in fixed exchange rates and floating exchange rates?
-Under fixed exchange rate systems, countries need to follow fiscal policies to maintain a low and stable rate of inflation
-Under dree floating exchange rates, it is corrected via currency depreciation, which may lead to cost-push inflation
Comparing and Contrasting Exchange Rate Systems
How does the flexibility offered to policy makers differ from fixed exchange rates to freely floating?
-Under fixed excahge rates, the government and central bank pursue a range of policies such as increasing interest rates, borrowing from abroad and pursuing contractionary fiscal and monetray policies
-Under freely floating exchage rates, domestic economic policy does not need to respond to balance of payments problems and can be carried out in accordance with domestic priorities.
