Question

Question 4 (international trade and foreign exchange):

(a) Your economy uses a fixed exchange rate system. Describe what is a fixed exchange system.

How does your country try to maintain this pegged rate?

(b) Explain what the trade weighted index is and how it is calculated. Who are the top five trading

partners for Australia and how do they influence the Australian TWI?

Answer 1

Ans (a): A fixed exchange rate is a regime applied by a government or central bank that ties the country's official currency exchange rate to another country's currency or the price of gold. The purpose of a fixed exchange rate system is to keep a currency's value within a narrow band.

Fixed rates provide greater certainty for exporters and importers. Fixed rates also help the government maintain low inflation, which, in the long run, keep interest rates down and stimulates trade and investment.

To maintain its exchange rate, the government will buy and sell its own currency against the currency to which it is pegged.

Ans (b): A trade weighted index is used to measure the effective value of an exchange rate against a basket of currencies. The importance of other currencies depends on the percentage of trade done with that country. A trade weighted index is useful for measuring the overall performance of a currency.

The trade-weighted exchange rate is calculated by taking into consideration the weights of shares of different currencies in trade of a country whose trade-weighted exchange rate is to be calculated.

Australia's top five trading partners were China, Japan, the United States, the Republic of Korea and India.