Topic 3 - Exchange Rate Systems

Question 1

What are the four diffferent Exchange rate systems? (Fxxxd, Frxxxy Flxxxxxg, Manxxxd Flxxxxxg, Pexxxd)

Answer 1

• Fixed Rate
• Freely Floating
• Managed Float
• Pegged

Question 2

In what ways can Governments directly intervene in the FX market?

Answer 2

By purchasing or selling currencies in the foreign exchange market.
- When a government purchases a currency in the foreign exchange market, it puts upward pressure on that currency’s equilibrium value
- When a government sells a currency in the foreign exchange market, it puts downward pressure on the currency’s equilibrium value

Question 3

Can Governments use indirect intervention to effect the FX market?

Answer 3

• Governments CAN use indirect intervention by influencing the economic factors that affect equilibrium exchange rates.
• Indirect intervention via an increase interest rates may attract more international capital flows, which may cause the local currency to appreciate

Question 4

Does a weaker Australian dollar stimulate the Australian economy?

Answer 4

• A weaker dollar stimulates the Australian economy by reducing Australian demand for imports and increasing foreign demand for Australian exports (as they can buy more AUD goods in the foreign currency)
• The weak Australian dollar tends to increase Australian employment but can also increase Australian inflation

Question 5

Can a strong AUD lead to higher levels of Australian unemployment?

Answer 5

YES
- When the RBA intervention strengthens the Australian dollar, the stronger dollar increases the Australian demand for imports and so intensifies foreign competition. The strong dollar can reduce Australian inflation but may lead to higher levels of Australian unemployment.