Christopher Aguilar Vazquez

Chapter 6 Assignment

1. Please provide examples for each of the exchange rate systems

Fixed Exchange Rates: A country's exchange rate regime in which a government or

central bank ties the official exchange rate to another country's currency or the price of
gold.

Hard Pegs: Achieved through dollarization or currency boards.

Dollarization: Situation where citizens of a country officially or unofficially use a foreign

country's currency as legal tender.

Currency Board: Extreme form of a pegged exchange rate in which management of

exchange rate and monetary supply are given to an agency with instructions to back
every unit of circulating domestic currency with a specified amount of foreign currency.

Soft-Crawling Peg: Currency with a fixed exchange rate system is allowed to fluctuate
within a band of rates. Par value of stated currency is adjusted frequently due to market
factors such as inflation.

Managed/ Dirty Float: Government or central bank occasionally intervene to change the
direction of countries' currencies.

Floating Exchange Rate: a country's exchange by the foreign exchange market through
supply and demand for currency.

2. What is a fixed exchange rate system and what is its difference with a free-
floating system?

A fixed exchange rate represents a nominal exchange rate that is set by the monetary
authority with respect of a foreign currency, and in the other hand the floating exchange
rate is determined in foreign exchange markets depending on demand and supply.

3. Explain pegged exchange rate system and dollarization. How are they similar and
different?

A currency peg is a policy in which a national government or central bank sets a fixed
exchange rate for its currency with a foreign currency and stabilizes the exchange rate
between countries. Dollarization is when a country begins to recognize the U.S. dollar as
 Christopher Aguilar Vazquez

a medium of exchange or legal tender alongside or in place of its domestic currency.

Even though both systems attempt to peg the value of the local currency, it does not
replace the local currency with dollars.

4. Explain why it would be virtually impossible to set an exchange rate between the
Japanese yen and the U.S. dollar and to maintain a fixed exchange rate.

A simple way of understanding why is that when a large increase in U.S. demand for yen
and no increase in supply of yen for sale, central banks would have to increase the
supply of yen in the market to offset increased demand. And would cause a change in
the equilibrium exchange rate.

5. Assume the Federal Reserve believes that the dollar should be weakened against
the Mexican peso. Explain how the Fed could use direct and indirect intervention
to weaken the dollar’s value with respect to the peso. Assume that future
inflation in the United States is expected to be low, regardless of the Fed’s
actions.

The Federal Reserve would limit the supply of dollars, which will cause more value to
the peso in relation to the US dollar. And also, the government might sell less of its
currency in order to low demand and lower its value.

6. Briefly explain why the Federal Reserve may attempt to weaken the dollar.

The reason why the government would attempt to devalue the dollar is to create
pressure on businesses engaged in importing and exporting. That would make an
increase in the economy growth and global trade.