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Chapter 19: Q.12 (page 528)

“The abandonment of fixed exchange rates after 1973 has meant that countries have pursued more independent monetary policies.” Is this statement true, false, or uncertain? Explain your answer.

Short Answer

Expert verified

The stated assertion is correct. The reason why a country in a recession does not want to intervene in the foreign exchange market if its currency is overvalued is that its currency is overvalued.

Step by step solution

01

Concept of foreign exchange market 

The term "foreign exchange market" refers to the market where currencies are exchanged. It is a location where people can trade currencies and where the supply and demand of a currency are decided, which affects the currency's foreign exchange rate.

02

Explanation

The term "recession" refers to a period of declining economic conditions. It occurs as a result of a drop in the gross domestic product (GDP) as a result of a fall in commerce and industrial activities.

If a country's currency is overvalued, it will not want to engage in the foreign exchange market during a recession. The reason for this is that participating in the foreign market would result in the central bank of the country selling its currency, lowering the value of that currency. The lower value will reduce commercial and industrial operations in that country, causing the country to enter a deeper recession.

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Most popular questions from this chapter

If the Federal Reserve buys dollars in the foreign exchange market but conducts an offsetting open market operation to sterilize the intervention, what will be the impact on international reserves, the money supply, and the exchange rate?

“Inflation is not possible under the gold standard.” Is this statement true, false, or uncertain? Explain your answer.

For each of the following, identify in which part of the balance-of-payments account the transaction is recorded (current account, capital account, or net change in international reserves) and whether it is a receipt or a payment.

a. A British subject’s purchase of a share of Johnson & Johnson stock

b. An American citizen’s purchase of an airline ticket from Air France

c. The Swiss government’s purchase of U.S. Treasury bills

d. A Japanese citizen’s purchase of California oranges

e. $50 million of foreign aid to Honduras

f. A loan from an American bank to Mexico

g. An American bank’s borrowing of euro dollars

If the Federal Reserve buys dollars in the foreign exchange market but does not sterilize the intervention, what will be the impact on international reserves, the money supply, and the exchange rate?

24. Suppose the Mexican central bank chooses to peg the peso to the U.S. dollar and commits to a fixed peso/ dollar exchange rate. Use a graph of the market for peso assets (foreign exchange) to show and explain how the peg must be maintained if a shock in the U.S. economy forces the Fed to pursue contractionary monetary policy. What does this say about the ability of central banks to address domestic economic problems while maintaining a pegged exchange rate?
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