Question

Which of the following explanation is NOT consistent with fixed exchange rate system?

a.

Central banks do not need foreign currency reserve at all.

b.

Under fixed exchange rate system, inflation can easily be spread among trading partners.

c.

Relatively easy to forecast exchange rate and thus it is helpful to increase trade.

d.

As the structure of a nation’s economy changes, the exchange rate should eventually be changed. But fixed system restricts this adjustment of relative price and the internal balance of payment adjustment process relies mainly on changes in the level of income (and hence employment).

Answer 1

Option A is the correct answer. It is incorrect to say that in a fixed exchange rate the central doesn't need any foreign exchange at all. Because foreign exchange is needed to purchase goods and commodity not available in the domestic economy. For instance, most of the nation keep foreign exchange to buy crude oil from gulf countries.