Which of the following correctly explains the potential disadvantage of a freely floating exchange rate regime? A freely floating exchange rate may compound a country’s inflationary problem. It is because if a country experiences high levels of inflation, its currency may weaken. A weaker currency can cause import prices to rise, which can increase the prices of materials and supplies and subsequently the price of the finished goods, compounding the country’s inflationary problem. A freely floating exchange rate regime may adversely affect a country that has high unemployment. It is because if the unemployment rate is high, the demand for import will decrease, putting appreciation pressure on the home currency. A stronger home currency will cause domestic consumers to purchase foreign, rather than domestic products, because the foreign products are now cheaper. This reaction of domestic consumers can be detrimental to a country during periods of high unemployment.
1. Which of the following correctly explains the potential disadvantage of a freely floating exchange rate regime?
A freely floating exchange rate may compound a country’s inflationary problem. It is because if a country experiences high levels of inflation, its currency may weaken. A weaker currency can cause import prices to rise, which can increase the prices of materials and supplies and subsequently the price of the finished goods, compounding the country’s inflationary problem.
A freely floating exchange rate regime may adversely affect a country that has high
All the arguments are correct
A freely floating exchange rate may compound a country’s inflationary problem. It is because if a country experiences high levels of inflation, its currency may weaken. Higher foreign prices may force domestic consumers to buy domestic products. Recognizing that their foreign competition has been reduced by the weak home currency, domestic producers may raise prices without fearing losing customers to foreign competition, compounding the country’s inflationary problem.
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