Answer to Question #274594 in Macroeconomics for gudwill

Question

a) How is money supply different in a fixed compared to a flexible exchange rate system? b) Explain why does monetary policy lose autonomy in a fixed exchange rate system ? c) Explain the assumptions of flexible exchange rate and fixed exchange rate. Which is an appropriate system for an small island economy of the Pacific ?

Answer 1

a.The fixed exchange rate system is called the exchange rate system in which the government and monetary authorities set the exchange rate system. It is not determined by the power of the market. 

 Flexible exchange rate system is an exchange rate system whose exchange rate depends on the supply and demand of money in the market.

b. This is because the central bank can no longer have any influence over the interest rate, exchange rate, or the level of GNP.

Fixed economy

-The fixed market system reduces the risk and uncertainty of currency fluctuations and facilitates trading.

-Fixed exchange rates lead to a lack of speculation. In the forex market. People believe that the exchange rate will remain the same for a long time without devaluation or rise.

Flexible exchange rate

-A flexible exchange rate system helps to automatically adjust the BOP.

-Flexible exchange rate system reduces the central bank's role in holding foreign exchange reserves.

majority of people living in the Pacific islands work in the service industry which includes tourism, education and financial services.