![]() By strengthening the domestic currency and weakening the foreign currency the downward pressure is offset and as a result the exchange rate remains at its fixed value. Probably the best reason to adopt a fixed exchange rate system is to commit to a loss in monetary autonomy. At the time of writing: - The US Federal Reserve 5 The Bank of England 4. The pros are that it eliminates market volatility and gives stability to financial markets. There are pros and cons to using a fixed exchange rate. This means that the value of one currency will not fluctuate in relation to another currency. To prevent the exchange rate from falling below the fixed rate the central bank sells foreign currency reserves to buy up domestic currency, which increases the demand for domestic currency and creates upward pressure. Interest rates are governed by each countries central bank. A fixed exchange rate is a monetary system where the value of one currency is fixed against another. Import restrictions are ineffective in increasing output d. An increase in the money supply, holding domestic credit fixed, implies that foreign reserves have gone up c. Devaluation of the exchange rate decreases output b. There is downward pressure brought about by an increase in the demand for the foreign currency due to an increae in demand for imports, this creates an excess supply for the domestic currency because when consumers buy foreign imports, they sell domestic currency to buy up foreign currency as the foreign imports are priced in terms of foreign currency. a fixed exchange rate regime, which of the following is true a. ![]() This downward pressure is enough to offset the upward pressure to maintain the fixed rate.īelow is a diagram to show how a central bank prevents the exchange rate fom moving below its target level to a lower free floating equilibrium. ![]() This new money is sold to acquire new foreign reserves, so that the foreign currency gets stronger and the domestic currency gets weaker. To prevent the exchange rate from rising above the fixed rate the central bank prints more money to increase the supply of money and devalue the currency to offset the upward pressure. There is upward pressure brought about by an increase in the demand for the domestic currency due to an increase in demand for exports, this creates an excess demand for the currency as shown below. It does this by buying and selling up foreign currency reserves.īelow is a diagram to show how a central bank prevents the exchange rate from moving above its target level to a higher free floating equilibrium. Where the central bank intervenes in foreign currency markets and alters the level of currency demand and supply to maintain the exchange rate at a specific level.
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