Question : Which of the following is a potential disadvantage of a fixed exchange rate system?
Option 1: Higher inflation rates
Option 2: Currency fluctuations
Option 3: Uncertainty in trade balances
Option 4: Speculative attacks on the currency
Correct Answer: Speculative attacks on the currency
Solution : The correct answer is d) Speculative attacks on the currency
A potential disadvantage of a fixed exchange rate system is the vulnerability to speculative attacks on the currency. When a country's currency is fixed to another currency or a specific value, it can become a target for speculators who believe the fixed rate is overvalued or unsustainable.
Speculative attacks involve investors or traders taking positions to sell the fixed currency in anticipation of a devaluation or a shift in the exchange rate regime. These attacks can put pressure on the central bank's reserves and may lead to a loss of confidence in the fixed exchange rate system.
However, it's important to note that a fixed exchange rate system may have other potential disadvantages, such as limited flexibility in adjusting to economic shocks, the need for significant foreign exchange reserves to defend the fixed rate, and potential constraints on independent monetary policy.
Related Questions
Trending Articles/News
