Question : Which of the following exchange rate systems allows the exchange rate to be freely determined by market forces but with occasional central bank intervention?
Option 1: Crawling peg exchange rate
Option 2: Fixed exchange rate
Option 3: Floating exchange rate
Option 4: Managed float exchange rate
Correct Answer: Managed float exchange rate
Solution : The correct answer is (d) Managed float exchange rate.
In a managed float exchange rate system, the exchange rate is primarily determined by market forces of supply and demand. However, the central bank or monetary authorities may occasionally intervene in the foreign exchange market to influence the exchange rate. The purpose of intervention is typically to smooth out excessive exchange rate fluctuations or to achieve certain policy objectives.
Under a managed float system, the central bank may buy or sell its own currency in the foreign exchange market to influence its value. For example, if the central bank believes that the currency is overvalued and hurting the country's export competitiveness, it may intervene by selling its own currency and buying foreign currency to increase the supply of the domestic currency and decrease its value relative to other currencies.
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