Topic E: Foreign Exchange

Question 1

Name the advantage of pegging your exchange rate (aka having a fixed exchange rate) If a country with a strong currency is pegged to and chooses to produce in a less affluent country with low production costs

Answer 1

• the stronger currency country prospers from producing at a low cost
• the less affluent country gains more profit when converting the stronger currency into their own

WIN WIN

Question 2

How does a pegged exchange rate reduce the chance of a currency crisis?

Answer 2

Protects a nation from volatile swings in the foreign exchange rate

Question 3

What is a disadvantage of a pegged exchange rate? hint inflation

Answer 3

A central bank must keep a large amount of reserves of a currency to keep it pegged which can induce inflation and higher prices