Capital Account

Question 1

Capital account

Answer 1

Minor payments/ transfers

Question 2

Floating exchange rate

Answer 2

Currency value set by market
Non government intervention
No target for exchange rate
Speculation causes change in floating exchange rate

Question 3

Advantages of a floating exchange rate

Answer 3

Reduces need to hold large foreign currency reserve
Freedom to set interest rates
Automatic correction
Less Risk

Question 4

Disadvantages of a floating exchange rate

Answer 4

Can be volatile- reduces FDI
A lower, more competitive exchange rate does not guarantee a current account surplus

Question 5

Fixed exchange rate

Answer 5

Government fixes currency value to another currency
Central bank must hold sufficient currency reserves

Question 6

Advantages of a fixed exchange rate

Answer 6

Stability attracts FDI
Stability controls inflation
Leads to lower borrowing costs
Less speculation

Question 7

Disadvantages of a fixed exchange rate

Answer 7

Cannot use interest rates in macro policies
Developing countries may not have sufficient foreign currency reserves to fix
Devaluation of exchange rate leads to cost-push inflation