What is an 'Arbitrageur' in the forex market?
- Someone who takes advantage of price differences for the same currency in different markets to make a risk-free profit.
- A high-ranking government official who sets the official exchange rate after consulting with the members of the Monetary Policy Committee and the Finance Ministry.
- A person who settles legal disputes between commercial banks and retail customers regarding the mis-selling of foreign exchange derivative products.
- A person who settles legal disputes between banks.
Explanation: Arbitrage helps in equalizing exchange rates across different global financial centers.
Which system provides the most 'Automatic Adjustment' to correct a trade deficit?
- Currency Board
- Fixed Exchange Rate
- Floating Exchange Rate
- Gold Standard
Explanation: In a floating system, a trade deficit increases the supply of domestic currency abroad, causing it to depreciate, which in turn makes exports cheaper and helps balance trade.
A 'Strong Currency' policy is generally good for:
- Consumers who want to buy imported goods and businesses that import raw materials.
- Exporters who want to sell more abroad.
- The domestic tourism industry which relies on attracting a high volume of foreign visitors who spend their foreign exchange within the country.
- Farmers who export their produce.
Explanation: A strong currency increases the domestic purchasing power for foreign goods and services.
What is 'Partial Convertibility' of the Rupee?
- Only 50% of the Rupee's value is recognized abroad.
- The Rupee is convertible for current account transactions but restricted for capital account transactions.
- Only the government can convert Rupees into Dollars.
- The Rupee can only be converted into gold.
Explanation: India allows free conversion for trade and services (Current Account) but regulates large-scale asset movements (Capital Account).
What is 'Devaluation' as opposed to 'Depreciation'?
- They are exactly the same concept used in different countries depending on whether they follow the civil law or common law legal tradition.
- Devaluation only applies to the value of silver and other precious metals used for minting coins before the transition to fiat currency systems.
- Devaluation is caused by market forces such as a drop in exports; Depreciation is a government policy involving the Central Bank's discount rate.
- Devaluation is a deliberate reduction in the value of a currency under a fixed exchange rate system.
Explanation: Devaluation is an administrative action in a fixed or pegged regime, whereas depreciation happens naturally in a floating regime.
What is 'Devaluation' in the context of exchange rates?
- The process of replacing old notes with new ones to prevent counterfeiting and black money circulation as seen in the 2016 Indian demonetization.
- A decrease in the value of a currency due to market forces in a floating system during a recession or a significant contraction in the industrial output.
- A deliberate downward adjustment of the official exchange rate by the government in a fixed system.
- The automatic increase in the purchasing power of the domestic currency due to high national growth and a surplus in the capital account of the BOP.
Explanation: Devaluation is an official act in fixed systems, whereas 'Depreciation' is the market-driven equivalent in floating systems.
In a 'Fixed Exchange Rate' system, if the demand for foreign currency increases, the Central Bank must:
- Do nothing and let the market decide the value of the currency based on supply and demand.
- Increase the tax on all exports to discourage foreign nations from buying domestic goods.
- Sell foreign currency from its reserves and buy domestic currency.
- Print more domestic currency and distribute it to commercial banks to increase liquidity.
Explanation: To keep the rate fixed, the central bank must supply the extra foreign currency demanded to prevent the domestic currency from depreciating.
What is 'Purchasing Power Parity' (PPP) theory?
- The theory that in the long run, exchange rates should move towards the rate that would equalize the prices of an identical basket of goods in any two countries.
- A specific trade policy mandated by the WTO requiring all member nations to eliminate non-tariff barriers and domestic agricultural subsidies by 2030.
- A system where every country in the global trade network uses the exact same digital currency backed by the Special Drawing Rights of the IMF.
- The idea that high-income individuals should pay a higher price for basic consumer commodities.
Explanation: PPP is often used to compare the standard of living between countries by adjusting for local price differences.
What is the 'Big Mac Index' used for?
- An informal way of measuring Purchasing Power Parity (PPP) between two currencies.
- Calculating the cost of cattle farming.
- Determining the tax on fast food.
- Measuring the health of citizens.
Explanation: Created by The Economist, it compares the price of a McDonald's Big Mac burger in different countries to see if currencies are 'overvalued' or 'undervalued'.
A 'Strong Currency' policy is often criticized because it:
- Hurts domestic exporters by making their goods more expensive for foreign buyers.
- Causes the national government to go bankrupt by increasing the cost of domestic debt interest.
- Reduces the central bank interest rates to zero and prevents any future economic growth.
- Makes imports too expensive for the local population and leads to a massive spike in inflation.
Explanation: While it controls inflation (cheaper imports), it can lead to a trade deficit and slow down the manufacturing sector.
In a 'Floating Exchange Rate' system, a 'Depreciation' of the domestic currency is caused by:
- An official decree by the Central Bank.
- An increase in the supply of the domestic currency relative to its demand in the forex market.
- An increase in the country's foreign exchange reserves.
- A significant and sudden decrease in the price of gold in the international market which reduces the intrinsic value of the national gold reserves.
Explanation: Depreciation is a market-driven event in a floating system. When more people want to sell the currency than buy it, its value falls.
Which of the following describes 'Currency Manipulation'?
- Investing in a diverse range of foreign stocks.
- Printing counterfeit money.
- When a country deliberately devalues its currency to gain an unfair competitive advantage in international trade.
- Changing the name of the national currency.
Explanation: By keeping its currency artificially weak, a country makes its exports much cheaper for the rest of the world.
Which of the following is a disadvantage of a 'Floating Exchange Rate' system?
- It introduces uncertainty for international trade due to frequent rate fluctuations.
- It makes it impossible to export any goods.
- It requires the government to set prices for all goods.
- It forces the central bank to keep zero reserves.
Explanation: Constant movement in rates can make it difficult for businesses to predict their long-term costs and revenues from abroad.
Which of the following is a 'Cost' of a Fixed Exchange Rate system?
- The need to maintain large foreign exchange reserves to defend the peg.
- Too much volatility in daily prices.
- Simplified international accounting.
- Low interest rates for everyone.
Explanation: To keep the rate fixed, the central bank must be ready to buy or sell its currency in unlimited quantities, requiring a huge reserve buffer.
If the Indian Rupee 'Appreciates' against the US Dollar, it makes:
- Indian exports cheaper and imports more expensive.
- Indian exports more expensive and imports cheaper.
- Both exports and imports more expensive.
- Both exports and imports cheaper.
Explanation: A stronger Rupee means foreign buyers need more of their currency to buy Indian goods, while Indians need fewer Rupees to buy foreign goods.
A 'Crawling Peg' is an exchange rate system where:
- The rate changes randomly every day.
- The currency is not convertible.
- The rate is adjusted periodically in small amounts based on a pre-announced mathematical formula.
- The rate is fixed forever.
Explanation: This allows for gradual adjustments to inflation without the shock of a major devaluation.
Which exchange rate system is most likely to lead to 'Currency Crises' due to reserve depletion?
- Pure Floating system where the central bank never intervenes in the foreign exchange market regardless of the impact on domestic inflation.
- Fixed Exchange Rate.
- Free Market system based on the principles of classical economics and zero government regulation.
- Managed Float system with occasional interventions to curb extreme market-driven volatility and maintain the stability of the capital account.
Explanation: Maintaining a peg requires constant intervention. If a country runs out of foreign reserves, it can no longer defend the peg, leading to a crash.
Which of the following would lead to an 'Appreciation' of the Indian Rupee in a floating system?
- A massive surge in Foreign Direct Investment (FDI) into India.
- An increase in the US Federal Reserve interest rates.
- A decrease in Indian exports.
- A sudden increase in oil prices globally.
Explanation: High FDI creates a high demand for Rupees to buy Indian assets, driving up its value relative to other currencies.
The 'LERMS' (Liberalized Exchange Rate Management System) introduced in India in 1992 was a:
- Gold standard system where the Rupee was directly convertible into a fixed weight of gold.
- Dual exchange rate system.
- Pure fixed rate system where the RBI controlled all foreign exchange transactions at one rate to maintain a surplus in the current account of the BOP.
- Pure floating system where the market determined the entire value of the Rupee immediately.
Explanation: Under LERMS, 40% of earnings were converted at the official rate and 60% at the market rate, acting as a transition to a market-based system.
What is the 'Nominal Effective Exchange Rate' (NEER)?
- An unadjusted weighted average of a currency's value against a basket of several foreign currencies.
- The inflation-adjusted value of the Rupee which takes into account the differences in the Consumer Price Index between India and its trading partners.
- The exchange rate between the Rupee and the US Dollar as quoted on the interbank forex market at the close of the business day in Mumbai.
- The rate at which the government buys gold to build the national reserves under the rules of the 1934 Reserve Bank of India Act.
Explanation: NEER shows the overall strength of a currency against its trading partners without adjusting for inflation.
What is the 'Nominal Effective Exchange Rate' (NEER)?
- The exchange rate between the domestic Rupee and the US Dollar as the primary global reserve.
- The interest rate at which commercial banks lend money to each other in the overnight market.
- A weighted average of bilateral exchange rates of a currency against a basket of currencies of its major trading partners.
- The rate shown on the television news and printed in the daily financial newspapers.
Explanation: NEER provides a broader view of a currency's overall strength rather than its performance against just one currency.
What is the 'Smithsonian Agreement' (1971)?
- The agreement that created the WTO.
- The agreement that created the Euro.
- The treaty that ended World War II.
- A short-lived attempt to save the fixed exchange rate system by realigning the Dollar against other currencies.
Explanation: It happened after the US suspended the gold convertibility of the Dollar, but the fixed system eventually collapsed anyway in 1973.
Under a 'Pure Float', the Central Bank:
- Never intervenes in the foreign exchange market.
- Only allows the national government to purchase US Dollars for the purpose of paying debt.
- Fixes the rate every morning at 10 AM based on the previous day's closing stock price.
- Is the most active participant in the market, buying and selling currency every single day.
Explanation: In a pure (clean) float, the exchange rate is entirely determined by the 'invisible hand' of the market.
What is 'Currency Substitution' (Dollarization)?
- Giving every citizen in the country a one-time grant of 100 US Dollars to boost spending.
- The illegal process of printing foreign US Dollars in a local factory using advanced technology.
- The use of a foreign currency (like the US Dollar) as a medium of exchange or legal tender alongside or instead of the domestic currency.
- A government tax on all foreign currency transactions conducted by private commercial banks.
Explanation: Countries with extreme hyperinflation often 'dollarize' to import the stability of the US monetary system.
The 'Impossible Trinity' or Trilemma in international macroeconomics suggests that a country cannot simultaneously have:
- A balanced budget, low taxes, and high public spending combined with a zero-interest rate policy.
- Low inflation, high growth, and low unemployment across all sectors of the domestic economy.
- Fixed exchange rate, free capital movement, and an independent monetary policy.
- High exports, low imports, and a strong currency maintained by strict labor market regulations.
Explanation: The Trilemma states that a country must choose two out of the three options; for example, if capital is mobile and the rate is fixed, the central bank loses control over domestic interest rates.
What is a 'Managed Float' (Dirty Float) system?
- A system where the exchange rate is determined solely by the number of annual exports and imports.
- A system where only gold is used for international trade settlements between various sovereign nations.
- A system where the rate is market-determined, but the central bank intervenes to prevent excessive volatility.
- A system where the exchange rate is fixed by the World Bank based on the country's debt-to-GDP ratio and its history of structural adjustment loans.
Explanation: India currently follows a managed float where the RBI allows the market to set the rate but steps in to curb 'wild' fluctuations.
The 'Real Effective Exchange Rate' (REER) is used to measure:
- A country's international competitiveness after adjusting for inflation differentials.
- The current price of the Dollar in Rupees.
- The total amount of cash in the economy as measured by the M3 broad money supply metric defined by the Reserve Bank of India.
- The exchange rate fixed by the IMF.
Explanation: REER is a weighted average of bilateral exchange rates adjusted for the relative price levels of trading partners.
The 'Gold Standard' was a system where:
- Currencies were defined in terms of a specific weight of gold, and were fully convertible into gold.
- Only gold coins were used for local transactions while paper money was used for external trade.
- The exchange rate was floating based on the discovery of new gold mines in various territories and the subsequent impact on the global supply of bullion.
- The government officially banned the use of paper money to ensure all trade was backed by metal.
Explanation: This created a self-regulating global system with very stable exchange rates but limited the flexibility of domestic monetary policy.
The 'Smithsonian Agreement' (1971) was an attempt to:
- End the Cold War through a series of trade agreements between the US and the Soviet Union focused on the reduction of nuclear armaments and wheat exports.
- Create the Eurozone and establish the European Central Bank as the primary financial authority.
- Abolish all national currencies and replace them with a single global currency backed by gold.
- Save the Bretton Woods system by realigning exchange rates and widening the bands.
Explanation: It was a short-lived attempt to maintain fixed rates after the US suspended gold convertibility; the system eventually collapsed in 1973.
Which of the following is an advantage of a 'Floating Exchange Rate' system?
- It eliminates exchange rate risk for all international traders and commercial banking institutions.
- It allows the country to maintain an independent monetary policy.
- It requires the central bank to hold massive gold and silver reserves to back the local currency value.
- It ensures that inflation is always kept at zero through rigorous market-based self-correction methods.
Explanation: Since the exchange rate adjusts to external shocks, the central bank can focus interest rate policy on domestic goals like inflation or growth.
The 'Bretton Woods System' (1944-1971) was characterized by:
- A global mandate that required every single participating country to abolish their local banking authority.
- A fixed-but-adjustable exchange rate system where currencies were pegged to the US Dollar, which was pegged to gold.
- The use of decentralized digital assets for all international trade settlements and debt payments as proposed by the G20 Financial Stability Board.
- A purely floating exchange rate system where no central bank held any foreign currency reserves under the original 1944 Articles of Agreement.
Explanation: It established a stable global environment post-WWII until the 'Nixon Shock' ended the dollar's convertibility to gold in 1971.
What is 'Hedging' in the foreign exchange market?
- The use of financial instruments (like forward contracts) to protect against the risk of adverse exchange rate movements.
- Refusing to trade with other countries to protect the domestic manufacturing sector from competition.
- Buying as much foreign currency as possible to make a speculative profit during a balance of payments crisis or a sharp decline in forex reserves.
- Planting a perimeter of trees around the central bank to ensure physical security and privacy.
Explanation: Hedging is essential for businesses to ensure they know the future cost or revenue of their international transactions.
Which of the following describes the 'Appreciation' of a currency?
- The government officially increasing the value of the currency through a legislative mandate.
- The collective feeling of economic gratitude that citizens have for their national currency following a successful period of export-led growth.
- An increase in the total amount of money supply circulating within the domestic economy leading to demand-pull inflation and a rise in the Consumer Price Index.
- The market-driven increase in the value of a currency relative to others in a floating system.
Explanation: Appreciation occurs when the demand for a currency exceeds its supply in the international forex market.
What is the 'Nominal' exchange rate?
- The rate that only exists on paper and not in real life.
- The average exchange rate over a period of 10 years used by the World Bank for the classification of countries into low, middle, and high-income groups.
- The exchange rate adjusted for the total number of people in a country to determine the per capita purchasing power in the international market.
- The simple price of one currency in terms of another without adjusting for inflation.
Explanation: It is the direct market rate you see at a bank or on a currency converter app.
The 'Plaza Accord' (1985) was an agreement among major economies to:
- Increase the value of the US Dollar to make imports cheaper for the American consumer and reduce the domestic rate of inflation during the Reagan era.
- Stop all international trading activities with China until environmental standards were met.
- Depreciate the US Dollar against the Japanese Yen and German Mark.
- Standardize the physical size and security features of all major international currency notes.
Explanation: It was a coordinated intervention to reduce the massive US trade deficit by making US exports more competitive.
What is 'Dollarization'?
- An increase in the value of the US Dollar.
- The process of printing Dollars in India.
- A tax on all transactions involving the Dollar.
- When a country stops using its own currency and adopts the US Dollar (or another foreign currency) as its legal tender.
Explanation: Countries often do this to stop hyperinflation and import the monetary credibility of a stable foreign nation.
Which of the following describes the 'Impossible Trinity' in international economics?
- Fixed exchange rate, free capital movement, and independent monetary policy.
- Balanced budget, zero debt, and high social spending.
- Strong exports, weak imports, and high foreign reserves.
- High real GDP growth, low retail inflation, and full employment within the formal sector as defined by the International Labour Organization (ILO).
Explanation: The trilemma states that a country can only choose two of these three options simultaneously. For example, if capital is mobile and the rate is fixed, the central bank cannot change interest rates independently of the peg.
India's transition to 'Current Account Convertibility' occurred in:
- 1994
- 1947
- 2016
- 1991, following the landmark budgetary speech by the then Finance Minister which initiated the Liberalization, Privatization, and Globalization reforms.
Explanation: Following the 1991 reforms, India accepted the obligations of Article VIII of the IMF, allowing free conversion of the Rupee for all trade-related transactions.
What is a 'Currency Board'?
- A stock exchange that only trades in currencies.
- The department in the RBI that prints money.
- A group of economists who advise the Prime Minister on trade.
- An extreme fixed exchange rate system where the domestic currency is 100% backed by a foreign reserve currency.
Explanation: Under a currency board, every unit of local currency issued must be backed by an equivalent amount of a foreign anchor currency.
In a 'Floating' system, if a country has high domestic inflation compared to its neighbors, its currency will likely:
- Appreciate due to the increased demand for domestic goods and services in the region.
- Remain fixed at the current level through the use of strict capital control measures and the suspension of the current account convertibility.
- Depreciate.
- Be abolished and replaced by a foreign reserve currency like the US Dollar or the Euro under the advice of the International Monetary Fund.
Explanation: High inflation reduces the purchasing power of the currency, making domestic goods less competitive and reducing the demand for that currency.
In a 'Managed Float', the RBI's primary objective is to:
- Prevent any foreign bank from operating in India.
- Maximize the value of the Rupee at any cost.
- Reduce volatility and maintain orderly conditions in the foreign exchange market.
- Ensure the Rupee is always weaker than the Yuan.
Explanation: The RBI does not target a specific level for the Rupee but intervenes to prevent sharp, disruptive spikes or falls.
The 'Managed Float' system, often used in India, is sometimes referred to as:
- Fixed Peg
- Dirty Float
- Gold Standard
- Pure Float
Explanation: It is called a dirty float because while the market mostly determines the rate, the central bank occasionally 'interferes' to stabilize the currency.
The 'Purchasing Power Parity' (PPP) theory suggests that exchange rates are determined by:
- The relative military strength of nations and their ability to enforce trade sanctions on neighboring states during times of geopolitical conflict.
- The decisions made at the G20 summit.
- The number of gold mines a country possesses and its ability to mint coins that are recognized as legal tender in the international commercial markets.
- The relative price levels of a basket of goods in different countries.
Explanation: PPP implies that in the long run, exchange rates should equalize the cost of an identical basket of goods in any two countries.
What is 'Speculative Attack' in a fixed exchange rate regime?
- Massive selling of a currency by investors who believe the government can no longer maintain the fixed peg.
- The process of buying massive quantities of gold during a festival to drive up the domestic price.
- A physical cyber-attack on the central bank infrastructure and the national electronic clearing system.
- An increase in the stock market index caused by an influx of foreign direct investment into tech.
Explanation: If the government runs out of reserves to buy back its currency during such an attack, the peg breaks, leading to a sharp devaluation.
A 'Floating Exchange Rate' system is also known as a:
- Flexible Exchange Rate system.
- Gold Standard system regulated by international bullion markets.
- Command Exchange system operated by the central planning committee.
- Pegged Exchange Rate system linked to a specific weight of platinum.
Explanation: In this system, the exchange rate is 'flexible' because it adjusts automatically to balance the demand and supply for foreign exchange.
What is 'Currency Hedging'?
- Selling all foreign currency to buy gold reserves to protect the national treasury from the impact of global geopolitical instability in the Middle East.
- Planting a perimeter of trees around the central bank to ensure physical security and privacy as part of a national green infrastructure project.
- Using financial contracts to protect against the risk of unfavorable exchange rate movements.
- Investing only in domestic companies.
Explanation: Exporters use hedging (like forwards or options) to lock in a specific exchange rate for future transactions.
The 'Bretton Woods System' (1944-1971) was essentially a:
- Barter system for international trade.
- System where no exchange rates existed.
- Fixed-but-adjustable system where currencies were pegged to the US Dollar.
- Purely floating exchange rate system where market forces determine the value of the currency without any intervention from the central bank or the IMF.
Explanation: Currencies were pegged to the Dollar, and the Dollar was pegged to Gold at $35 per ounce.
The 'Gold Standard' was a system of:
- Managed floats.
- Digital currency.
- Floating exchange rates.
- Fixed exchange rates.
Explanation: Under the Gold Standard, each currency was pegged to a specific amount of gold, resulting in fixed exchange rates between all participating nations.
Which of the following is an advantage of a 'Fixed Exchange Rate' system?
- It eliminates the need for foreign exchange reserves.
- It automatically prevents inflation.
- It provides certainty and stability for international trade and investment.
- It allows for an independent monetary policy that enables the central bank to set interest rates according to the specific needs of the domestic economy.
Explanation: Predictable exchange rates reduce the 'exchange rate risk' for exporters and importers, encouraging long-term contracts.
The 'LERMS' (Liberalized Exchange Rate Management System) introduced in India in 1992 was a:
- Gold standard.
- Pure floating system.
- Fixed rate system.
- Dual exchange rate system.
Explanation: Under LERMS, 40% of foreign exchange earnings had to be surrendered at the official rate, while 60% could be sold at market rates.
What happens during a 'Speculative Attack' on a fixed currency?
- Investors buy the currency in large amounts to support the government.
- Investors sell the currency rapidly, betting that the central bank will run out of reserves to maintain the peg.
- The government bans the use of foreign currency.
- The stock market reaches an all-time high following the announcement of a landmark free trade agreement with the European Union or the United States.
Explanation: If the central bank cannot buy back the currency being sold, it is forced to devalue or float the currency.
Which of the following describes a 'Fixed Exchange Rate' system?
- The exchange rate changes every hour based on stock market performance and global trade indices.
- The value of the currency is determined solely by market demand and supply forces without intervention from the Reserve Bank of India or the Ministry of Finance.
- The value of the currency is pegged to another major currency or a basket of currencies by the government.
- The central bank prohibits any form of external trade or currency conversion for all private citizens.
Explanation: In a fixed (or pegged) system, the central bank intervenes to maintain the currency's value within a very narrow band relative to the peg.
In the context of the Impossible Trinity, if a country allows free capital movement and has an independent monetary policy, it must have:
- A Fixed exchange rate.
- No central bank.
- A Floating exchange rate.
- A Gold standard.
Explanation: By allowing the exchange rate to float, the country gains the freedom to set its own interest rates while allowing capital to flow in and out.
What is 'Arbitrage' in the forex market?
- The process of charging excessively high fees for currency conversion at international airports.
- The simultaneous purchase and sale of a currency in different markets to profit from a price discrepancy.
- A legal dispute between two commercial banks over the ownership of foreign exchange reserves.
- A government tax on currency profit earned by individuals through international trade activities.
Explanation: Arbitrageurs ensure that exchange rates remain consistent across different global financial centers.
Which system provides the greatest 'Automatic Stabilizer' for a country's Balance of Payments?
- Floating Exchange Rate.
- Currency Board system with 100 percent backing by foreign liquid assets.
- Gold Standard where currency is directly convertible into a fixed weight of gold.
- Fixed Exchange Rate system maintained by aggressive central bank intervention.
Explanation: In a floating system, a trade deficit leads to currency depreciation, which naturally makes exports cheaper and imports costlier, helping to correct the deficit.
What is a 'Currency Board' system?
- A system where all commercial and retail banks are owned and operated by the sovereign state.
- An extreme form of fixed exchange rate where the domestic currency is 100% backed by a foreign reserve currency.
- The specific department within the central bank that handles the printing and distribution of currency notes and manages the security features of fiat money.
- A group of appointed economists who decide the exchange rate every day at the morning market open based on the previous day's closing price of crude oil.
Explanation: Countries like Hong Kong use this to ensure total stability and credibility of their peg to a major currency.
The 'Real Exchange Rate' (RER) is calculated by adjusting the nominal exchange rate for:
- The total population density and the average household income level of the two trading nations.
- The gold price index and the global value of silver as determined by the London Bullion Market.
- The difference in price levels (inflation) between two countries.
- The physical geographic distance and transportation costs between the two trading partner countries.
Explanation: RER measures the relative purchasing power and competitiveness of a currency; $RER = e imes (P^* / P)$.
What is a 'Crawling Peg'?
- A system where the exchange rate is fixed but adjusted frequently in small amounts to account for inflation differentials.
- A system where the exchange rate is determined by a random lottery held by the finance ministry.
- A system where the currency value is adjusted once every decade based on the national census data.
- A purely floating system with high volatility caused by speculative activities in the market.
Explanation: It allows a country to maintain the benefits of a peg while avoiding the massive shocks associated with a single large devaluation.
Which of the following is a 'Cost' of a Fixed Exchange Rate system?
- High transaction costs for travelers when they convert money at the national border due to the lack of an integrated digital payment system like the UPI.
- Too much uncertainty and risk for international trade and long-term foreign investment which discourages the entry of multinational corporations.
- Constant and unpredictable changes in the daily price of basic consumer goods like bread.
- Loss of 'Monetary Sovereignty' (ability to set domestic interest rates).
Explanation: To maintain the peg, the central bank must adjust interest rates to mirror the peg-country's rates or to manage capital flows.
Which of the following describes the 'J-Curve' effect?
- The trade balance first worsens and then improves over time after a currency depreciation.
- The historical relationship between marginal tax rates and the total amount of tax revenue collected by the government as proposed by Arthur Laffer.
- The path of economic growth after a recession where the economy first experiences a sharp dip and then a rapid V-shaped recovery to the pre-crisis level.
- The trade balance improves immediately after a devaluation due to the instantaneous rise in the demand for domestic exports in the global market.
Explanation: Initially, the cost of imports rises immediately, but it takes time for consumers and businesses to adjust their volumes, leading to an initial dip.