Question : Assertion: A country with a fixed exchange rate regime has limited control over its monetary policy.
Reason: In a fixed exchange rate system, the central bank must intervene to maintain the exchange rate at the specified level, which restricts its ability to independently set interest rates.
Option 1: True, as the central bank needs to prioritize exchange rate stability over domestic monetary policy objectives.
Option 2: True, only if the country has a large foreign exchange reserve.
Option 3: False, as fixed exchange rate regimes provide more flexibility in implementing monetary policy.
Option 4: False, as countries with fixed exchange rates have complete control over their monetary policy.
Correct Answer:
True, as the central bank needs to prioritize exchange rate stability over domestic monetary policy objectives.
Solution : The correct answer is (a) True, as the central bank needs to prioritize exchange rate stability over domestic monetary policy objectives.
A country with a fixed exchange rate regime indeed has limited control over its monetary policy. In a fixed exchange rate system, the central bank intervenes in the foreign exchange market to maintain the exchange rate at the specified level. This intervention often requires the central bank to use its foreign exchange reserves and adjust interest rates to align with the target exchange rate. As a result, the central bank's ability to independently set interest rates and pursue domestic monetary policy objectives is constrained by the need to prioritize exchange rate stability. Therefore, countries with fixed exchange rates have less flexibility in implementing monetary policy compared to countries with floating exchange rates.
