Chapter 6

Question 1

What is a fixed exchange rate system?

Answer 1

It is a system where exchange rates are held constant or allowed to fluctuate only within narrow boundaries, requiring frequent government intervention

Question 2

What is the primary advantage of a freely floating exchange rate system?

Answer 2

It insulates a country from the inflation and unemployment of other countries without requiring central bank intervention

Question 3

How does a pegged exchange rate system work?

Answer 3

A country’s currency is pegged to another currency, and the value moves in line with the pegged currency against other currencies

Question 4

How do central banks use direct intervention to influence exchange rates?

Answer 4

They buy or sell currencies in the foreign exchange market to adjust the currency’s supply and demand, thus influencing its value

Question 5

What is the difference between sterilized and nonsterilized intervention?

Answer 5

In sterilized intervention, the central bank offsets its foreign exchange market actions by also engaging in domestic actions like buying or selling Treasury securities

Question 6

How can governments use indirect intervention to influence exchange rates?

Answer 6

By adjusting factors like interest rates, inflation, and income levels or imposing foreign exchange controls to affect the currency’s value

Question 7

What is a major disadvantage of the Eurozone for individual countries?

Answer 7

Countries cannot control their own monetary policy and must rely on a single policy applied to all Eurozone members.

Question 8

How can a financial crisis in one Eurozone country affect other Eurozone countries?

Answer 8

Financial problems in one country can spread to others due to interconnected banking systems and shared reliance on the euro

Question 9

What is the role of the European Central Bank (ECB) in the Eurozone?

Answer 9

The ECB sets monetary policy for the Eurozone, controlling inflation and stabilizing the euro’s value