Question

Many countries experiencing high and rising inflation, or even hyperinflation, will adopt a fixed exchange rate regime. This is because:

A. the ensuing increase in trade lowers inflationary pressures

B. To maintain the peg, monetization of the debt must end, expectations of inflation will go down.

C. inflation, in practice and reality, always equals the inflation of the currency to which you are pegging.

D. the peg is always a credible commitment, which will lower long-term spreads

Answer 1

Option. C

inflation, in practice and reality, always equals the inflation of the currency to which you are pegging.

A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another measure of value, such as gold.

A fixed exchange rate system can also be used to control the behavior of a currency, such as by limiting rates of inflation. However, in doing so, the pegged currency is then controlled by its reference value. As such, when the reference value rises or falls, it then follows that the value(s) of any currencies pegged to it will also rise and fall in relation to other currencies and commodities with which the pegged currency can be traded.

In a fixed exchange rate, you need to keep inflation low, otherwise the currency will start to fall below the target level. Pegging a currency stabilizes the exchange rate between countries. Doing so provides long-term predictability of exchange rates for business planning