Question

Define:

Fully convertible currency

Exchange controls

Clean float v. dirty managed float

Fixed exchange rate – what to fix it to and how often to change it

Adjustable peg and crawling peg

How does a government defend a fixed exchange rate

Answer 1

a. A fully convertible currency is the one that does not have any government restrictions in trading and is trusted by Central Banks and corporations. The examples of fully convertible currencies are the US Dollar and Euro.

b. Exchange controls: In order to stabilize exchange rate volatility and economies of the countries, there are government imposed limitations on the purchase and sale of currencies in the market.This helps in limiting inflows and outflows of currencies in the economy and control exchange rate fluctuations.

c. Clean float v. dirty managed float ; In case of clean floating, the exchange rate is determined by the free market forces of demand and supply. The foreign exchange market itself corrects the excess demand or supply conditions without the intervention of monetary authority.

Dirty Managed Float: Exchange rate is determined by the free market forces of demand and supply but the monetary authority intervenes in the market by pegging operations to smoothen the fluctuations in the exchange rate.

d. Fixed exchange rate : When the value of the currency is tied to another country's currency or the price of gold, then the exchange rate is referred to as fixed exchange rate.