Read The Following Scenario And Explain Which Exchange Rate
Read The Following Scenario And Explain Which Exchange Rate System Is
Read the following scenario and explain which exchange rate system is best suited and explain your rationale of why the exchange rate system you chose is the most appropriate for the situation. The small country of San Pon in China participates in exchange rate activities. The country they anticipate exchanging with has a struggling economy and jobs are scarce. The currency has lost a significant amount of value, but the country is in need of the currency exchange. The exchange rates have fluctuated quickly over the past six months and the government has become involved on several occurrences and altered the value of the currency more. Under what exchange rate system should San Pon exchange with another country and why or why not?
Paper For Above instruction
The scenario presented involving San Pon, a small country in China experiencing significant currency depreciation and rapid exchange rate fluctuations, underscores the importance of selecting an appropriate exchange rate system that aligns with its economic conditions. Given the dynamic and unstable currency environment, the most suitable exchange rate system for San Pon is a managed float, also known as a hybrid system, which combines elements of free-floating and fixed exchange rates.
A managed float system allows the currency's value to fluctuate according to market forces, but with occasional intervention by the government or central bank to stabilize or influence the currency's value. This approach provides flexibility in responding to economic shocks, such as the rapid declines observed in San Pon's currency, while also enabling the government to prevent excessive volatility that could harm economic stability (Clarida, 2014).
In the context of San Pon’s currency neccessity for exchange despite its depreciation, a pure free-floating system might pose risks due to the extreme volatility observed over the past six months. Uncontrolled fluctuations could result in unpredictable costs for international trade and investment, which could further destabilize an already struggling economy. Conversely, a fixed exchange rate system—where the currency’s value is pegged to another stable currency or basket of currencies—may not be appropriate either, since the government has already intervened multiple times and altered currency value, indicating an inability or unwillingness to commit to a fixed rate that could hamper economic flexibility.
Additionally, a fixed system could be challenging to implement effectively in a context of rapid and unpredictable currency movements, as the country's reserves would need to be substantial to maintain the peg, and continued interventions might deplete those reserves, ultimately risking a currency crisis (Eichengreen, 2019). Therefore, a managed float offers a balanced solution, permitting some degree of market-determined exchange rate movement, with strategic interventions to mitigate extreme fluctuations when necessary.
Furthermore, adopting a managed float aligns with San Pon’s current need to facilitate currency exchange amidst a depreciating currency environment. This system enables the government to intervene selectively to support the currency during periods of sharp decline, thereby maintaining economic stability and encouraging international trade and investments. It also offers the flexibility to adapt to evolving economic conditions without the rigid commitments of a fixed exchange rate.
Overall, the managed float system is most appropriate for San Pon because it provides a pragmatic approach to managing currency fluctuations in a volatile environment. It allows policymakers to respond effectively to economic shocks, avoid severe instability, and support the country’s participation in international trade despite its currency devaluation challenges. As San Pon navigates its economic struggles, adopting a managed float will help balance market forces and government interventions to promote stability and growth.
References
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