What does a fixed exchange rate policy typically involve?

What does a fixed exchange rate policy typically involve?

• A. Fluctuating currency value
• B. Government commitment to a specific value
• C. Complete market freedom
• D. High volatility in currency exchange

Answer: (B)

A fixed exchange rate policy involves a government's commitment to maintain the value of its currency at a specific exchange rate against another currency or a basket of currencies. This commitment stabilizes the currency's value over time, allowing for predictability in international trade and investment. By pegging the currency, the government often intervenes in the foreign exchange market to align the actual market exchange rate with the fixed target, which can help mitigate the risks associated with fluctuating currency values. This approach contrasts with fluctuating currency values, where exchange rates would naturally change based on market forces, resulting in potential volatility and uncertainty for businesses and consumers. It also differs from complete market freedom, where currency values are left to be determined by supply and demand without government intervention, leading to unpredictability. High volatility in currency exchange is typically seen under systems without a fixed rate, reflecting erratic market conditions rather than a stable, committed approach like that of a fixed exchange rate policy.

A fixed exchange rate policy involves a government's commitment to maintain the value of its currency at a specific exchange rate against another currency or a basket of currencies. This commitment stabilizes the currency's value over time, allowing for predictability in international trade and investment. By pegging the currency, the government often intervenes in the foreign exchange market to align the actual market exchange rate with the fixed target, which can help mitigate the risks associated with fluctuating currency values.

This approach contrasts with fluctuating currency values, where exchange rates would naturally change based on market forces, resulting in potential volatility and uncertainty for businesses and consumers. It also differs from complete market freedom, where currency values are left to be determined by supply and demand without government intervention, leading to unpredictability. High volatility in currency exchange is typically seen under systems without a fixed rate, reflecting erratic market conditions rather than a stable, committed approach like that of a fixed exchange rate policy.