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International Economics
(a) What are the alleged advantages of a fixed over a flexible exchange rate system?
How do advocates of flexible exchange rates respond?
Fixed exchange rate system guards against wild day-to-day fluctuations which discourage specialization in production and flow of international trade and investment a position that advocates of flexible exchange rate detest. They aver that destabilizing speculation is less likely to occur when exchange rates adjust continuously.
In the wake of alleged advantages that fixed exchange rate has over flexible exchange rate it has been established that pegging exchange rate at a given unit has its inherent excesses in demand or supply with regard to foreign exchange. Flexible exchange rate is regarded as efficient because exchange rate does not have to change to correct the equilibrium in the nation's balance of payments (Salvatore, 1996). Flexible exchange rates are integral when it comes to correcting balance...
This stabilizes speculations. This in a way interferes with smooth flow of international trade and investments. Using a flexible exchange rate, a country can use fiscal policies to internally balance its economy it can also use monetary policy to achieve external balance. Achievement on internal balance can essentially be attained if monetary policies are free to be used alongside fiscal policies. Policy mistakes and delays in achieving external balance can be minimized if flexible exchange rate system is used (Salvatore, 1996). Flexible exchange rate system is handy in preventing the government from setting the exchange rate at a level other than equilibrium.
(b) What overall conclusion can be reached on whether flexible or fixed exchange rates are preferred?
Flexible and fixed exchange rate systems should interchangeably be used. Government should have some hand in the foreign exchange market to smoothen out excessive…
The world today operates under a managed float which was formalized during the 1976 Jamaica Accords. The formation of the European Monetary System and subsequent operationalization of the European Central Bank has eased borrowing pressures from the IMF. There are also other credit facilities that have come up. However, during the gold standard period, the fact that one unit of each currency was fixed, the exchange rates also became fixed (Salvatore, 1996). A country's money supply would fall if a deficit nation loses gold. This subsequently stimulated the amount of goods exported by such countries while also discouraging its imports until the balance of payment deficit is eliminated. The reverse happened for surplus nations.
(b) Why the different economic conditions today would make the reestablishment of a smoothly working gold standard impossible.
Formation of trading blocks like the European Union and operationalization of the European Central Bank among other economic unions has led to reduction of pressure that IMF used to soak in as the only lending agency. Countries can access loan facilities from alternate financial institutions. Exchange rates are also flexible far from what it
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