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Chapter 30: Problem 1

What is an exchange rate system? What is the difference between a fixed exchange rate system and a managed float exchange rate system?

Short Answer

Expert verified
An exchange rate system is the method a monetary authority uses to manage its currency in relation to other currencies and the foreign exchange market. A fixed exchange rate system maintains a certain exchange rate through direct intervention by the monetary authority. A managed float exchange rate system allows the exchange rate to fluctuate due to market forces, but the monetary authority may intervene to prevent sharp or disruptive changes.

Step by step solution

01

Explain Exchange Rate System

An exchange rate system, or regime, is the way a monetary authority of a country manages its currency with respect to other currencies and the foreign exchange market.
02

Define Fixed Exchange Rate System

In a fixed exchange rate system, the government or central bank maintains the exchange rate of its currency at a certain level or within a range against another currency, often by buying or selling its own currency on the open market.
03

Define Managed Float Exchange Rate System

In a managed float exchange rate system, also known as a 'dirty float', a country's exchange rate is normally allowed to fluctuate according to market forces and the central bank will only intervene to prevent sharp changes and to maintain stability.
04

Differences Between Fixed and Managed Float Exchange Rate Systems

In a fixed exchange rate, the rate is set and maintained by the government and does not fluctuate day-to-day. In contrast, in a managed float system, although the rate is generally free to fluctuate, the government or central bank may intervene to stabilize the market if it considers the currency's value is moving too sharply or disruptively.

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Most popular questions from this chapter

Although it is a member of the European Community, Denmark is not part of the euro zone; it has its own currency, the krone. Because the krone is pegged to the euro, Denmark's central bank is obliged to maintain the value of the krone within 2.25 percent either above or below the value of the euro. According to a 2017 article in the Wall Street Journal, the Danish central bank was forced to intervene in foreign currency markets "to keep the krone from strengthening too much." a. If the krone was strengthening, did it take more kroner to exchange for a euro or fewer kroner? Briefly explain. b. Given your answer to part (a), was the Danish central bank intervening by buying kroner in exchange for euros or selling kroner in exchange for euros? Briefly explain.

How were exchange rates determined under the gold standard? How did the Bretton Woods system differ from the gold standard?

Which European countries currently use the euro as their currency? Why did these countries agree to replace their previous currencies with the euro?

(Related to the Chapter Opener on page 1058 ) An article in the Wall Street Journal in June 2017 began with this observation: "The euro soared to its biggest one-day gain against the dollar in a year." Bayer AG sells Coppertone sunscreen in the United States. If Bayer produces Coppertone in the United States and sells it only in the United States, would an increase in the value of the euro against the dollar affect the company's profit from selling Coppertone? Briefly explain.

After World War II, why might countries have preferred the Bretton Woods system to reestablishing the gold standard? In your answer, be sure to note the important ways in which the Bretton Woods system differed from the gold standard.
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