Explain how the exchange rate gets determined in a flexible exchange rate system.
What will be an ideal response?
If the foreign exchange rate floats freely, the demand for and the supply of foreign currency determine foreign exchange rates. The exchange rate for any foreign currency is the rate at which the quantity of that currency demanded is equal to the quantity supplied. A change in the demand for or the supply of foreign currency will cause a change in the exchange rate for that currency. When there is an increase in the price paid in dollars for a foreign currency, the dollar has depreciated and the foreign currency has appreciated in value. Conversely, when there is a decrease in the price paid in dollars for a foreign currency, the dollar has appreciated and the foreign currency has depreciated in value.
The demand for and supply of a foreign currency can change for many reasons. These shifts occur because of changes in tastes, relative incomes, relative price-levels, relative interest rates, and speculation.
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The real interest rate equals the
A) nominal interest rate - inflation rate. B) nominal interest rate + inflation rate. C) (nominal interest rate ÷ inflation rate). D) inflation rate - nominal interest rate. E) (nominal interest rate + inflation rate) × 100.
When it became known in 1997 that the Thai government had insufficient foreign exchange reserves to maintain the exchange rate, how did currency speculators respond? What policy did the IMF suggest?
What will be an ideal response?