Floating Exchange Rates Quiz

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Questions and Answers

What is the primary advantage of floating exchange rates?

Less vulnerability to speculative attacks (correct)

Stable exchange rates and prices

Higher need for governments to maintain reserves

Easier control of inflation

In a floating exchange rate system, what typically happens when a country's currency appreciates?

Exports become more expensive for foreigners (correct)

Foreign goods become cheaper for domestic consumers

Imports become more expensive for domestic consumers

Relative price of exports increases

Which of the following is a disadvantage of floating exchange rates?

No volatility in exchange rates or prices

Harder control or reduction of inflation (correct)

Easy control over exchange rate movements

Lower need for governments to hold reserves

How does depreciation affect a country's exports and imports?

Imports become cheaper for domestic residents Signup and view all the answers

Why does a country's currency appreciation lead to higher relative prices of its exports?

Foreigners pay more for the country's products Signup and view all the answers

What is one consequence of managed floating exchange rates?

Increased vulnerability to speculative attacks Signup and view all the answers

What is the characteristic of a spot exchange rate?

Payments are settled immediately Signup and view all the answers

What is the purpose of official international reserves?

To cushion against national economic misfortune Signup and view all the answers

Which institution is responsible for managing the supply of money?

Central bank Signup and view all the answers

Which factor determines whether a currency is traded at a forward premium or forward discount?

Interest rate of the country Signup and view all the answers

What do autonomous transactions refer to in the context of balance of payments?

Transactions affected by factors outside the balance of payments statement Signup and view all the answers

What does the real exchange rate account for?

Differences in inflation rates among countries Signup and view all the answers

What is the evidence of balance of payments disequilibrium according to the text?

Accommodating transactions Signup and view all the answers

How is the real exchange rate (R) calculated?

$R = e \times \frac{P(home)}{P(foreign)}$ Signup and view all the answers

In foreign exchange intervention, why do central banks often buy or sell international reserves in private asset markets?

To affect macroeconomic conditions in their economies Signup and view all the answers

What does a rise in the real exchange rate indicate?

Real appreciation Signup and view all the answers

Which situation signifies a real depreciation according to the text?

Fall in the real effective exchange rate Signup and view all the answers

What determines net capital movements according to the text?

Interest rate and exchange rate considerations Signup and view all the answers

Study Notes

Floating Exchange Rates

A floating exchange rate is a system where the exchange rate is allowed to fluctuate in response to changing economic conditions.
In a managed floating exchange rate, the nation's central bank intervenes regularly in foreign exchange markets.
Countries adopting floating exchange rates include Philippines, United States, and South Korea.

Advantages of Floating Exchange Rates

Adjusts to shocks and imbalances
Less vulnerable to speculative attacks
No need for governments to keep reserves

Disadvantages of Floating Exchange Rates

Volatile exchange rates and prices
Harder to control or reduce inflation

Depreciation and Appreciation

Depreciation occurs when there is a fall in the value of a currency in a floating exchange rate.
Appreciation occurs when there is an increase in the value of a currency in a floating exchange rate.
Depreciation makes a country's goods cheaper for foreigners, while appreciation makes its goods more expensive.
Depreciation raises the relative price of imports, while appreciation lowers the relative price of imports.

Exchange Rates

Spot exchange rate: the exchange rate at which transactions are settled immediately (within two working days).
Forward exchange rate: a contract to exchange currencies in 30, 60, 90, or 180 days.
The currency of the country with lower interest rates trades is at a forward premium.
The currency of the country with higher interest rates trades is at a forward discount.

Real Exchange Rate

Real exchange rate: an exchange rate that covers the differences between the inflation rates or general price levels among countries.
R = e × P(home)/P(foreign)
A rise in the real exchange rate indicates a real appreciation.
A fall in the real exchange rate indicates a real depreciation.

Demand and Supply of Foreign Exchange

The exchange rate is the price.
Autonomous transactions: independent of the balance of payments, including exports, imports, transfers, and net capital movements.
Accommodating (offsetting) transactions: occurring to compensate for differences between payments and receipts arising from a country's autonomous transactions.

Central Bank and Official International Reserves

Central bank is the institution responsible for managing the supply of money.
Official international reserves: foreign assets held by central banks as a cushion against national economic misfortune.
Official foreign exchange intervention: central banks buying or selling international reserves to affect macroeconomic conditions in their economies.

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Description

Test your knowledge about floating exchange rates, where exchange rates are allowed to fluctuate in response to changing economic conditions. Learn about the advantages and disadvantages of countries adopting this system.