Real-World Examples of Fixed and Floating Exchange Rates in Action

📚 Quick Study Guide

• 🌍 Fixed Exchange Rate: A system where a country's currency value is pegged to another currency (like the US dollar) or to a commodity (like gold). The government or central bank actively intervenes in the foreign exchange market to maintain this fixed value.
• ⚖️ Floating Exchange Rate: A system where a currency's value is determined by the supply and demand forces in the foreign exchange market. The government or central bank generally does not intervene (or intervenes minimally).
• 🔑 Devaluation: When a country intentionally lowers the value of its currency in a fixed exchange rate system.
• 📈 Appreciation: When a currency's value increases in a floating exchange rate system due to market forces.
• 📉 Depreciation: When a currency's value decreases in a floating exchange rate system due to market forces.
• 🏛️ Central Bank Intervention: Actions taken by a central bank to influence the value of its currency. In a fixed exchange rate system, intervention is crucial for maintaining the peg.
• 🧮 Real Exchange Rate: The nominal exchange rate adjusted for differences in price levels between countries. Formula: $Real\ Exchange\ Rate = Nominal\ Exchange\ Rate * (Domestic\ Price\ Level / Foreign\ Price\ Level)$

Practice Quiz

1. Which of the following is a key characteristic of a fixed exchange rate system?
   1. A) Currency value determined by market forces.
   2. B) Government or central bank intervention to maintain a pegged value.
   3. C) No central bank involvement in the foreign exchange market.
   4. D) Currency value fluctuates freely.
2. In a floating exchange rate system, what primarily determines a currency's value?
   1. A) Government decree.
   2. B) Central bank mandate.
   3. C) Supply and demand in the foreign exchange market.
   4. D) International agreements.
3. What is the term for when a country intentionally lowers the value of its currency in a fixed exchange rate system?
   1. A) Appreciation.
   2. B) Depreciation.
   3. C) Devaluation.
   4. D) Revaluation.
4. If the nominal exchange rate between the US dollar and the Euro is 1.10 (1 Euro = 1.10 USD), and the price level in the US is 100 while the price level in the Eurozone is 90, what is the real exchange rate?
   1. A) 0.99
   2. B) 1.00
   3. C) 1.22
   4. D) 1.10
5. Which of the following is a typical action taken by a central bank in a fixed exchange rate system?
   1. A) Buying or selling its own currency to influence its value.
   2. B) Setting interest rates only based on domestic inflation.
   3. C) Ignoring the foreign exchange market.
   4. D) Encouraging free market speculation.
6. What happens to a currency's value in a floating exchange rate system when there's increased demand for that currency?
   1. A) It depreciates.
   2. B) It remains constant.
   3. C) It appreciates.
   4. D) It is pegged to another currency.
7. Which of these countries, at some point in history, has attempted to maintain a fixed exchange rate system?
   1. A) United States (currently)
   2. B) Switzerland (currently)
   3. C) China (historically)
   4. D) United Kingdom (currently)