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Advantages of Fixed and Flexiable Exchange Rate Systems

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1. A. What are the alleged advantages of a fixed over a flexible exchange rate system? How do advocates of flexible exchange rates respond?
B. What overall conclusion can be reached on whether flexible or fixed exchange rates are preferred?

2. What is meant by a crawling peg system? How can such a system overcome the disadvantage of an adjustable peg system?

A. How economic conditions today differ from those prevailing under the gold standard period.
B. Why the different economic conditions today would make the reestablishment of a smoothly working gold standard impossible.

4. A. With respect to a nation with a $100-million quota in the IMF, indicate how the nation was to pay in its quota to the IMF and the amount that the nation could borrow in any one year under the original rules.
B. How are the rules different today?

5. Explain the role of the dollar under the Bretton Woods System.

6. Explain briefly the operation of the present international monetary system.

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Solution Summary

The advantages of fixed and flexible exchange rate systems are discussed. The crawling peg system is analyzed.

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Question 1A
Under a fixed exchange rate system, the government and its financial system can easily anchor hyper- and high inflation which is usually observed in almost emerging countries at one time or another. However, according to the advocates of the flexible exchange rate system, this same characteristic of the fixed exchange rate system makes it inferior in absorbing shocks from open capital markets which can result to economic catastrophe like what happened in several Asian economies during the 1997 financial crisis.
Moreover, under a fixed exchange rate system, a country can not maintain an indecent open capital market and monetary policy at the same time which seems to be an important success factor in a global economic environment. On the other side, a fixed exchange rate system is better when it comes to reducing or eliminating exchange rate volatilities which makes it more effective an deficient in distributing the burden of adjustment between the external sector and the domestic economy during economic shocks.
Question 1B
The preferred exchange rate system should be ...

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