If You Were Elected To Choose Between A Fixed Or Floating

If you were elected to choose between a fixed freely floating or

1. If you were elected to choose between a fixed, freely floating, or a dirty float exchange rate system, which would you choose for your home country? Why? (KOREA)

2. Assume that both the U.S. and Europe experience high unemployment. How can the U.S. central bank attempt to adjust the dollar value to reduce this problem? Is the European central bank likely to go along with the U.S. central bank’s strategy or retaliate? Why?

Paper For Above instruction

The choice of an exchange rate system is a critical decision for a country’s economic stability and growth prospects. When considering options such as fixed, freely floating, or dirty float systems, it is vital to analyze the economic context, policy flexibility, and the implications on monetary sovereignty. For South Korea, a strategic decision must balance maintaining stability, controlling inflation, and supporting economic growth amidst global market volatility.

South Korea’s economy is highly export-driven, with strong links to international markets, making exchange rate stability particularly important. Given this context, a dirty float system—where the currency largely floats but with occasional intervention—could be optimal. This approach allows South Korea to respond to external shocks and prevent excessive volatility that could damage exports and economic stability. Unlike a fixed exchange rate, which requires significant interventions that could drain foreign reserves and distort markets, or a fully floating rate that may lead to unpredictable swings, a dirty float provides a pragmatic compromise, balancing market-determined rates with monetary intervention when necessary.

Implementing a dirty float system would enable Korea’s policymakers to maintain some control over the won’s value during periods of excessive volatility. This strategy supports export competitiveness while allowing the exchange rate to fluctuate based on market forces, thus preventing the currency from becoming overvalued or undervalued. Additionally, this approach offers flexibility to respond to external shocks such as global financial crises or geopolitical tensions, which can significantly impact currency stability.

Moving to the second scenario involving the U.S. and Europe facing high unemployment, monetary policy responses become crucial. The U.S. Federal Reserve, aiming to stimulate the economy, might consider devaluing the dollar through methods such as lowering interest rates or engaging in quantitative easing. A weaker dollar can boost exports by making American goods cheaper abroad, thereby stimulating demand and potentially reducing unemployment. The Fed might also communicate its intentions to influence market expectations or intervene directly in currency markets to manage the dollar’s value.

However, the European Central Bank (ECB) is likely to react cautiously. As the euro zone’s economy is interconnected, the ECB’s primary concern is maintaining price stability within its member countries. If the U.S. devalues the dollar aggressively, it could lead to currency tensions and retaliatory actions, impacting global economic stability. The ECB might see the U.S. strategy as potentially harmful if it results in excessive exchange rate volatility or competitive devaluations, known as currency wars. Consequently, the ECB might oppose or hesitate to follow the U.S. approach, preferring coordinated monetary policies or other fiscal measures to address unemployment challenges without engaging in competitive devaluations.

In conclusion, the choice of an exchange rate system hinges on the specific economic objectives and vulnerabilities of a country. For South Korea, a flexible yet managed system like the dirty float offers an optimal balance. Regarding international monetary responses, coordination and cautious strategies are essential, especially considering the potential for conflicting policies and retaliations that could exacerbate economic instability during periods of high unemployment.

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