Question

26. Explain how balance-of-trade equilibrium is maintained under the gold standard.

27. Illustrate it your explanation with an example

28. What are the arguments that favor a floating exchange rate system against a fixed exchange rate system.?

29. How can international companies reduce their economic exposure in a world of constantly fluctuating exchange rates?

Answer 1

26 and 27.

A country is in balance-of-trade equilibrium when the income its residents earn from exports is equal to the money its residents pay to other countries for imports Under the gold standard, if a country A has a trade surplus, there will be a net flow of gold from the country B to A. These gold flows automatically reduce the B's money supply and swell A's money supply. An increase in money supply will raise prices in A, while a decrease in the B's. money supply will push B's prices downward. The rise in the price of A's goods will decrease demand for these goods, while the fall in the prices of B's goods will increase demand for these goods. Thus, A will start to buy more from the B, and the B will buy less from A, until a balance-of-trade equilibrium is achieved. Example- A can be USA and B can be UK.

28. The majojr advantage of floating exchange rates is that they leave the monetary and fiscal authorities free to pursue internal goals like full employment, stablity in growth, price stability. Exchange rate adjustment often works as an automatic stabilizer to promote those goals. Major advantage of fixed exchange rates is that they promote international trade and investment, which can be an important source of growth in the long run, particularly for developing countries.

29. The best way to reduce their economic exposure from constantly fluctuating exchange rates is through Hedging, by managing two types of foreign currency risk which are transaction risk and translation risk.