10 Questions
What is a key benefit of a country having an undervalued currency?
It can help the country gain large reserves of foreign currencies
What is the term used to describe China's current exchange rate regime?
Managed float
What is a benefit of a free floating exchange rate?
It eliminates the need for high levels of foreign currency reserves
What is a disadvantage of a free floating exchange rate?
It tends to create uncertainty on international markets
Why may the Chinese central bank intervene in the currency market?
To stimulate the economy during periods of low export demand
What is a result of a fixed exchange rate?
It can lead to high levels of foreign currency reserves
What is a factor that can affect a floating exchange rate?
All of the above
What is a potential consequence of a floating exchange rate regime?
It can worsen existing levels of inflation
What is a key difference between a managed float and a free float?
The level of government intervention
What is a benefit of a fixed exchange rate?
It reduces the uncertainty of international markets
Study Notes
Currency Management Systems
- A country has more control over its currency when it's undervalued, as it can gain large reserves of foreign currencies.
Undervalued Currencies
- China operates a managed float currency system, intervening when necessary to stimulate its markets.
- China previously operated a fixed exchange rate at around 8 RMB to the US dollar, but adjusted it when needed.
Free Floating Advantages and Disadvantages
- Advantages:
- The floating exchange rate should adjust itself to keep the current account balanced.
- No need to keep high levels of foreign currency and gold reserves.
- Disadvantages:
- Creates uncertainty on international markets.
- Affected by factors beyond demand and supply, such as government intervention and world events.
- May worsen existing levels of inflation.
Fixed Exchange Rate Advantages vs Disadvantages
- Advantages:
- Reduces uncertainty for economic agents in the country.
- Ensures sensible government policies on inflation.
- Reduces speculation in foreign exchange markets.
- Disadvantages:
- Requires high levels of foreign reserves to defend the currency.
- Setting the fixed exchange rate level can be challenging.
- A fixed rate set too low may create international disagreement.
Effects of Exchange Rates on Economy
- High exchange rate:
- Downward pressure on inflation.
- More imports can be bought.
- Forces domestic producers to improve efficiency.
- Disadvantages of high exchange rates:
- Damage to export industries.
- Damage to domestic industries.
- Low exchange rate:
- Greater employment in export industries.
- Greater employment in domestic industries.
- Disadvantages of low exchange rates:
- Imports become more expensive.
- Can lead to inflation.
Test your understanding of fixed exchange rates, including their impact on inflation, exports, and government policies. This quiz covers the advantages of fixed exchange rates, such as reducing uncertainty and speculation in foreign exchange markets.
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