Suggest the best exchange rate system for a country like Zambia.

Expert Solution

Floating exchange rate

Floating exchange regimes are useful for countries such as Zambia where foreign trade is relatively low as a percentage of GDP and real exchange rate volatility does not affect domestic prices, wages, and interest rates that decide equilibriae to real domestic variables. It is assumed that such an economy has a high level of domestic savings and that its technological development attracts foreign capital.

Small economies, by comparison, are dependent on foreign trade to accumulate international reserves. Their need for capital imports requires a high degree of predictability of the exchange rate, and thus their central bank plays a more active role in the forex market, ensuring that there are no speculative attacks on the domestic currency. To this end, to ensure price and growth stability, prudent monetary and fiscal policies must be in place, as well as low inflation.

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Rahul Sunny answered 2 years ago

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