Exchange rate regimes

Question 1

• Draw a simple diagram outlining the options facing countries in terms of objectives for: monetary policy, capital account liberalisation, and exchange rate regime. Identify where China, Australia, US and Hong Kong currently lie on this diagram.

Answer 1

Triangle -> Exchange rate stable > (China) >Monetary policy independence > (Aus/US) > Open Capital Account > (HK) > Exchange rate st…

Question 2

All of a sudden, a country with a fixed exchange rate faces a large outflow of capital. What are the two main ways a country can defend their exchange rate? (4 marks). Name a country that has experienced this in recent decades (1 mark).

Answer 2

Build up substantial foreign exchange reserves
Distort monetary policy

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Question 3

Why is a monetary/currency union without a fiscal union likely to become unsustainable?

Answer 3

Monetary Policy is imported from group, may not be applicable for specific country (lack of flexibility)

Question 4

What are some of the key requirements for a currency union to be successful? (5 marks)

Answer 4

labour mobility across region (ability to travel - visa), lack of cultural barriers, institutional arrangements 2. openness with capital mobility and price and wage flexibility across the region (optimal allocation of money and goods) 3. fiscal integration to some degree (risk sharing system, automatic fiscal transfer to redistribute money) 4. participant countries have similar business cycles. Otherwise common MP unlikely to be suitable