Question

1. An important difference between fixed and floating exchange rates is the impact on monetary policy. This difference is framed by some economists as being a benefit of floating exchange rates, but other economists frame the same thing as a benefit of fixed exchange rates. Explain each side of the argument, and then give your own opinion.

Answer 1

A fixed exchange rate is the point at which a country fixes its cost in terms of another currency or gold. This way, currency advertise fluctuations or monetary fluctuations around the globe don't influence the country's exchange rate in terms of different currencies. In contrast, having a floating exchange rate means letting the market for currencies decide the exchange rate between the two countries.

Having a fixed exchange rate somewhat limits the capacity of the central bank to impact the money supply, yield, and work in the economy. Suppose the central bank decides to increase the money supply in the economy. An increase in the money supply causes the interest rates in the economy to go down. Presently since the home country's interest rates have fallen, the outside country's currency will be sought after.

Presently if the exchange rate was floating, this would prompt the energy about the outside currency and devaluation of the home currency. At the end of the day, the exchange rate would rise. In the event that the exchange rate here is fixed, to keep up the exchange rate, the central bank of the home country would sell its reserves of remote currency to compensate for the excess interest. Presently in doing this transaction, the home currency is being used and is thus removed from dissemination. This offsets the expansionary fiscal approach that the central bank expected to follow.

All together for money related strategy to have any effect on financial yield and business, the exchange rate must be floating. An expansionary money related strategy will cascade into an increase in the degree of total interest and yield.