Question

1. YOUR GRADE DEPENDS ON YOUR CONVICTION, CORRECTNESS, ELABORATION AND ELUCIDATION OF YOUR ANSWERS.
2. YOU SHOULD WRITE ABOUT ONE PAGE SINGLE SPACED

Explicate how the exchange rates, in a flexible exchange rate regime and in a fixed exchange rate world, are affected by deficits and surpluses.

Answer 1

Flexible exchange rate system is a system in which rate will be determined by the market force and it will be dependent upon various types of market factors and it will include the domestic strength of the company and the the domestic weakness of the company and when there will be deficit in an economy, it will mean that it will be leading to a weaker domestic currency because this will be a negative sign about stability of the economy and then the economy will be trying to devalue its currency in order to have a better foreign exchange reserve in order to stabilize the difference in the valuation of the currency so there will be a impact of deficit and surplus directly through market forces in flexible exchange rate system because market forces will be trying to discount deficit and surplus quickly into their exchange rate.

Fixed exchange rate system is a system in which government will be setting and maintaining the official exchange rate and it will be helping in stabilizing the atmosphere of the foreign investment but when there will be a deficit or surplus of the foreign exchange in the economy, then it will mean that, government will be trying to intervene and they will be trying to maintain the appropriate rate in order to manage through deficits in the economy so they will be trying to adopt" crawling peg " when they will be reassessing the value of peg periodically and then they will be changing the great accordingly so this will be causing devaluation but it is controlled to avoid the market panic.