Most countries today use floating exchange rates. However, through the history o

Question

Most countries today use floating exchange rates. However, through the history of the international monetary system, countries have adopted different approaches to fixing exchange rates. The hope was to facilitate trade and reduce the risk associated with buying foreign goods and assets. There is still considerable debate about the merits and drawbacks of fixed exchange rates 44.1. Which of the following is true of fixed exchange rates? A. Because the central bank is responsible for maintaining the fixed exchange rate, it is not free to use monetary policy in response to economic conditions. B. With a fixed exchange rate, the balance of payments equals the sum of the current account and the capital account. C. Under the Bretton Woods system, major currencies were pegged to the value of the euro. D. Adoption of a single currency, such as the euro, has the problem of exchange rate instability E. All these choices

Explanation / Answer

Answer.) A.) Because the central bank is responsible for maintaining the fixed exchange rate, it is not free to use monetary policy in response to economic conditions.

Maintaining a fixed exchange rate through intervention means that a country cannot use discretionary monetary policy to influence the economy. This loss of monetary policy occurs because in order to maintain a fixed exchange rate, the monetary base and the money supply become a function of the country’s external balance.

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