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Chapter 22: Problem 11

Under a fixed exchange rate system, setting the official price of a peso in terms of dollars automatically sets the official price of a dollar in terms of pesos. Do you agree or disagree? Explain.

Short Answer

Expert verified
Yes, agree. In a fixed exchange rate system, when a government sets the official price of its own currency (a peso) in terms of a foreign currency (like the dollar), it automatically determines what the official price of that foreign currency will be in terms of its own.

Step by step solution

01

Understanding fixed exchange rate

A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by the government to a certain value. This could be to a single fixed value or a relative value of a foreign currency. It includes maintaining of exchange rate within certain limits.
02

Explaining the effect on prices

In a fixed exchange rate system, when a government sets the official price of its own currency (for instance, a peso) in terms of a foreign currency (like the dollar), it automatically determines what the official price of that foreign currency will be in terms of its own.
03

Conclusion

This results from the reciprocal nature of exchange rates - if one peso were set at a value of half a dollar, for example, then the value of a dollar in terms of pesos would be automatically set at two. Therefore, in a sense, agreeing with the statement is correct as the setting of the official value of a peso in dollars would indeed set the official price of dollar in pesos.

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Most popular questions from this chapter

Under a flexible exchange rate system, if the equilibrium exchange rate is \(0.10 \mathrm{USD}=1 \mathrm{MXN}\) and the current exchange rate is \(0.12=1 \mathrm{MXN},\) will the U.S. dollar appreciate or depreciate? Explain.

If everyone in the world spoke the same language, would the world be closer to or further from being an optimal currency area? Explain.

A country whose currency is the primary reserve currency can likely borrow at lower interest rates than it could if its currency were not the primary reserve currency. Do you agree or disagree? Explain.

What does it mean to say that the U.S. dollar has depreciated in value in relation to the Mexican peso? What does it mean to say that the Mexican peso has appreciated in value relative to the U.S. dollar?

What are the strong and weak points of the flexible exchange rate system? What are the strong and weak points of the fixed exchange rate system?
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