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Economics A Level
Macro - Paper 2
Fixed Vs Floating
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Created by
Toby Landes (GRK7)
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Cards (8)
Fixed
exchange rate
Exchange rate set and maintained by government
intervention
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Floating exchange rate
Exchange rate determined by
market
forces of
supply
and
demand
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Advantages of floating exchange rates
Reduces
need
for currency reserves
Allows domestic
monetary
policy to work freely
Can help correct current account deficits
automatically
Useful tool for
macroeconomic
adjustment
Less risk of currency being over/undervalued
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Disadvantages of floating exchange rates
No guarantee of
stability
- can be volatile
Volatility
reduces incentives for foreign investment and trade
Automatic
current account
deficit
correction is mainly theoretical
Can
worsen
inflation issues
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Advantages of fixed exchange rates
Lowers
exchange rate uncertainty, promoting investment and trade
Allows some
flexibility
through bands and revaluation/devaluation
Reduces costs of
hedging
in futures markets
Disciplines
domestic
producers to improve efficiency
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Disadvantages of fixed exchange rates
Using
interest rates
to maintain can have negative
macroeconomic
consequences
Maintaining large foreign currency reserves may not be
viable
Risk of speculative attacks if rate is
misaligned
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Most economies use
floating
exchange rates, but allow room for government
intervention
if needed
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China is an example of a country that
intervenes
frequently in its floating exchange rate
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