fixed vs floating exchange rates

Question 1

benefits of floating exchange rates

Answer 1

• decreased need for currency reserves
  -freedom for domestic monetary policy
  -useful instrument for macro adjustment
  -partial automatic correction for trade deficit

Question 2

negatives of floating exchange rate

Answer 2

-volatility
-self correction of trade deficit unlikely

Question 3

benefits of fixed exchange rates

Answer 3

-reduced risk of exchange rate uncertainty: exporters and importers know it will be stable: FDI
-some flexibility: will often have a band, can also devalue/value currency
-reduction in cost of trade
-discipline of domestic producers

Question 4

issues of fixed exchange rates

Answer 4

-interest rate effects: may have to raise interest rates if undervalued
-large level of foreign currency reserves
-speculative attacks if it is too high