Page 212 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes From the above merits and demerits of fixed and flexible exchange rates, it is difficult to conclude
that either rigidly fixed or freely floating exchange rates are likely to be put into practice.
Self-Assessment

1. Choose the correct options:
(i) Floating exchange rates
(a) tend to correct balance of payments imbalances
(b) reduce the uncertainties and risks associated with international trade
(c) increase the world's need for international monetary reserves
(d) tend to expand the volume of world trade
(ii) If Canada has floating exchange rates, and a capital account deficit
(a) Canada has a current account deficit
(b) Canada is losing international reserves
(c) Canada has a current account surplus
(d) Canada is gaining international reserves
(iii) If a nation has a current account deficit of 6 and a capital account surplus of 2
(a) the nation gains 8 in international reserves
(b) the nation loses 8 in international reserves
(c) the nation gains 4 in international reserves
(d) the nation loses 4 in international reserves
(iv) When the balance on Canada's official settlement account is positive
(a) Canada's balance on current + capital accounts is negative, and we are gaining
international reserves
(b) Canada's balance on current + capital accounts is positive, and we are gaining
international reserves
(c) Canada's balance on current + capital accounts is negative, and we are losing international
reserves
(d) Canada's balance on current + capital accounts is positive, and we are losing international
reserves
(v) Which of the following is a disadvantage of a flexible exchange rate system?
(a) nations must keep large reserves of gold or foreign currencies
(b) flexible rates usually tend to produce inflation
(c) uncertainty that tends to inhibit trade
(d) all of the above
18.3 Summary

• The present unit discusses the exchange rate adjustment policies that have been in vogue from
time to time with the establishment of the IMF. Before we discuss them, it is instructive to have
a theoretical interlude relating to fixed and fluctuating exchange rates.
• As with a hard peg, the drawback of a fixed exchange rate is that it gives the government less
scope to use monetary and fiscal policy to promote domestic economic stability. Thus, it leaves
countries exposed to idiosyncratic shocks not shared by the country to which it has fixed its
currency. As explained above, this is less of a problem than with a hard peg because imperfect
capital mobility does allow for some deviation from the policy of the country or countries to
which you are linked. But the shock would need to be temporary in nature because a significant
deviation could not last.

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