Country X and Country Y are capable of producing both apples and bananas. Assume a two-country, two-product model.
Country Y has absolute advantage in the production of both apples and bananas, and comparative advantage in the production of bananas.
Explain two reasons why a government might prefer a floating exchange rate system for its currency.
Level
Marks
0
The work does not meet a standard described by the descriptors below.
1
The written response is limited.
1-2
For stating one reason [1]. For explaining one reason OR for stating two reasons [2].
2
The written response is accurate.
3-4
For stating one reason AND explaining one reason [3]. For explaining two reasons [4].
Reasons may include:
- a floating exchange rate system allows for independent monetary policy. Interest rates can be set in order to influence AD without fear of disrupting the (fixed) exchange rate
- the economy can use exchange rate policy to affect macroeconomic variables, such as the growth rate;
inflation)
- if an economy has a current account deficit/surplus, the exchange rate will act as a self-regulating mechanism to restore the balance
- the central bank does not need to maintain foreign reserves: (involving an opportunity cost) to be able to intervene in the foreign exchange market.
Any other reasonable response should be rewarded.