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 of payments disequilibria smoothly and continuously. 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 short-term fluctuations.
6. What is meant by a crawling peg system? How can such a system overcome the disadvantage of an adjustable peg system?
Crawling peg system is where par values or exchange rates are changed by very small preannounced amounts at frequent and clearly specified intervals up to when equilibrium exchange rate is attained. With the crawling peg system nations can prevent destabilizing speculation as opposed to adjustable peg system which is thought to cause destabilizing fluctuation (Salvatore, 1996)
Chapter 16
1. Explain:
(a) How economic conditions today differ from those prevailing under the gold standard period.
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