Economics Multiple Choice (1 Viewer)

[amberbambi]

Hey guys

Could someone explain the reasoning behind this qn? It's from the 2010 HSC

Which scenario best demonstrates the benefits of a fixed exchange rate system?
A) a country experiencing a recession fixes its currency to that of a country in which interest rates are low
B) a country experiencing a boom fixes its currency to that of a country experiencing a recession
C) a country experiencing a recession fixes its exchange rate above the equilibrium rate
D) a country experiencing a boom fixes its exchange rate below the equilibrium rate

Thanks

 

[Evertone]

D.

This is because when you're experiencing a boom, countries buying your exports will push your dollar up.

The more people buying the Aussie dollar, the less of our currency is available.

In year 11, you learn that people who compete to purchase a product which is in low supply will demand to pay a higher and higher price for that product to outbid or 'kill off' others. Now, while currency transactions don't exactly work like a property auction, it still reflects how the dynamics work.

That's why they have a thing called the Dutch disease, where one industry pushes the dollar up and kills all others in the process.

The boom might turn into a bust since the appreciation it has caused might mean that industries will become less competitive, e.g. manufacturing.

This is because exports will cost more to buy from a country experiencing an appreciation rather than a depreciation.

So if you're experiencing a boom, which (typically) has the automatic consequence of appreciating your dollar, then keeping it low is an advantage.

This is precisely why China is doing so well.

My response is quite fragmented so that it can make more sense.

 

[BoredofBoredofS]

D.

This is because when you're experiencing a boom, countries buying your exports will push your dollar up.

The more people buying the Aussie dollar, the less of our currency is available.

In year 11, you learn that people who compete to purchase a product which is in low supply will demand to pay a higher and higher price for that product to outbid or 'kill off' others. Now, while currency transactions don't exactly work like a property auction, it still reflects how the dynamics work.

That's why they have a thing called the Dutch disease, where one industry pushes the dollar up and kills all others in the process.

The boom might turn into a bust since the appreciation it has caused might mean that industries will become less competitive, e.g. manufacturing.

This is because exports will cost more to buy from a country experiencing an appreciation rather than a depreciation.

So if you're experiencing a boom, which (typically) has the automatic consequence of appreciating your dollar, then keeping it low is an advantage.

This is precisely why China is doing so well.

My response is quite fragmented so that it can make more sense.

While I agree with this statement, IMO the reasoning is a little convoluted, especially for a multiple choice question which usually would not expect you to use this higher order thinking - If a country is experiencing a boom, fixing the exchange rate below equilibrium will devalue it more and encourage increased growth, which is a major problem for economies as it can lead to uncontrollable inflation, so i personally think that the reasoning of Dutch Disease is very much a special case and not suitable for the MC answer. Instead, why not A? In a recession, fixing it to an economy with low interest rates (implied low dollar) would depreciate the currency, increasing its growth and thereby moving it into an upswing phase.